Dow Theory Update for June 30: Secondary (bearish) Reaction for stocks since June 29

No time now for deep explanations, which will come tomorrow, if time allows.

Take my word: The secondary trend for US Stocks turned bearish on June 29.

Sincerely,

The Dow Theorist

Dow Theory Special Issue: Maximum Drawdown and average returns for the Dow Theory versus buy and hold

Trends remain unchanged.

This post is the detailed answer to one question posed by a follower of this Dow Theory blog. Hope it will serve Algyros and other readers to further a deeper understanding of the Dow Theory.

 Here is question:

"I was wondering if you had CAGR and Max DD backtested information for your flavor of the Dow Theory for a meaningful expanse of time. I hesitate to ask because I imagine that this information is somewhere in this blog, but, I've not succeeded in unearthing it."

And here is my answer:

Hi Algyros,

I am quite leery as to CAGR and such measures, as markets and future performance are not so easily tamed by past performance figures. Furthermore, the Dow Theory is a process, and hence, its practitioners should perform their own calculations. A figure such as CAGR means nothing, if the investor has not fully apprehended the intricacies of the Dow Theory. The courage to stick to the Dow Theory when there is an under performing spell, and there are many as I explained here, will come by fully internalizing the Dow Theory, not by its “dry” performance figures. Thus, rather than just looking at a CAGR figure, it is much more important to understand how fared the Dow Theory during secular bear markets, during past market crashes, and the like. Averages such as CAGR are misleading, and I feel it is more important to focus on the market traps that inevitably we’ll have to confront sooner or later. 

Having said this, I can give you the following information:

a) Here you can find a comparison of “buy and hold” versus Schannep’s Dow Theory. I created the charts and calculations using TradeStation®. You find the details enabling you to calculate CAGR in the link I have provided. Since the start capital for the simulation was USD 100 K, you can by yourself derive the CAGR made by Schannep’s Dow Theory versus the CAGR of buy and hold. Please mind that dividends have not been considered. More information as to Schannep’s out performance, in his master book “The Dow Theory for the 21^st Century” and his website “thedowtheory.com”.

b) From the link I have provided, you can see that the deepest drawdown was caused by a string of three consecutive losses for a total loss of -19%. I insist you can download on Schannep’s site his Dow Theory track record so that you get the details of each signal (or you can find them in his book as well). By contrast, “buy and hold” had to endure three times drawdowns in the vicinity of -50% (in the seventies, 2000-2002 and 2008-2009)

c) Nobody knows whether the Dow Theory will encounter in the future a longer string of losing trades, thereby causing “death by a thousand cuts”. What would happen if the Dow Theory were to find six consecutive losers (something which hitherto has never occurred)? Well, knowing that (a) the average loss for Schannep’s Dow Theory is in the vicinity of -6.5% (why?: here), we could extrapolate that under a spell of very bad luck, the Dow Theory could endure a drawdown of ca. 30%-39%, which remains well below buy and hold (and furthermore, the likelihood of its ocurrence is more remote than for buy and hold, since we can see that in ca. 60 years buy and hold has declined more than 50% three times, whereas this has not happened one single time when following the Dow Theory). This is not a bad assumption. Traders say that “your worst drawdown is always ahead of you”, and, hence, in the very long run, it is likely that the hitherto made worst drawdown is going to be exceeded. Furthermore, another assumption of traders, is to just double the hitherto realized worst drawdown to estimate your worst drawdown in your career. Thus, if we take the hitherto worst drawdown of ca. -19% and double it we get -38%. Please mind, that these are just approximations. Nobody can predict the future, and we are at the mercy of the markets. However, we have reached a similar figure of the worst "likely" draw down we could encounter in the future by performing two different calculations.

d) To fully apprehend why Schannep’s Dow Theory outperforms buy and hold by ca. 4%, and, more importantly, when and why such outperformance occurs, I encourage you to read this study:

http://www.dowtheoryinvestment.com/p/face-off-schannep-versus-classical-dow.html

The issue of draw downs is a very important one (this is what traders refer as "risk of ruin") and it pertains to extrapolating what the future has in store for the Dow Theory. I am cogitating a future new saga of posts which would bear  roughly the following name: "Putting the Dow Theory under stress-test". The past +115 years have been, after all, very lenient for US stocks. How would the Dow Theory fare under radically adverse market conditions? I have studies of the Dow Theory performance under secular bear markets (which remains positive and with contained drawdowns), and hence we can get a foretaste of the looks of adverse market conditions. However, what I have in mind for my test is even more adverse market conditions. How would the Dow Theory perform if we were to encounter 10 years with an average decline of -7% annual? What if the economy enters a deflationary spiral of -5% p.a. with real GDP contraction of -4% p.a. during ten years? Would the Dow Theory scape unscathed (buy and hold wouldn't)? Which market conditions would result in 10 consecutive losing trades? Is the Dow Theory inherently protected against such a string of 10 consecutive losers (I feel "yes")? Why? All these are questions that hopefully I plan to write about in the future (If time allows).

Sincerely,

The Dow Theorist.

P.S. In spite of all market volatility with Greece, etc.,  primary and secondary trends remain unchanged for US Stocks, US debt, Gold, Silver, and their miners ETFs. As to Chinese stocks, they are immersed in a secondary bearish reaction against the primary trend, but have not set up yet for a primary bear market.

Dow Theory Update for June 24: Gary Antonacci on stops. Let’ s heed the words of a sage

Trends remain unchanged

There are three names that shine when it comes to (a) investment practical acumen; (b) avoid BS. These names are (in alphabetical order):

1) Antonacci.

http://www.dualmomentum.net/

2) Moening

http://stateofthemarkets.com/

3)  Schannep

http://thedowtheory.com/

I have praised Antonacci’s work in the past (here and here). He has recently penned a new article entitled “Momentum and Stop Losses” which proves that stops:

a) slightly raise average returns (please mind that the goal of any trend follower is not to greatly improve buy and hold, but merely, avoid costly drawdowns).

b) Reduce the standard deviation of returns (hence, less likelihood of a killing drawdown).

c) Result in a positive skewness (which is a good thing).

  

I encourage you to read Antonnaci's article as well as the links he provides. 

I derive two ideas from his article:

a) Stops make sense. If markets trend, then when momentum increases against my position the odds favor that a new trend against my position is being born, and hence, it is sensible to “cut losses short”.

b) The Dow Theory itself is the best “stop”. In essence, the Dow Theory is a breakout strategy. The entries (“bull market signals”) are merely “buy stops” (break up points) and the exit (“primary bear market signal”) is clearly the “stop” that stop us out. However, Dow Theory “stops” are miles apart from “normal” breakout stops. Normal stops are set at a predefined level (i.e. 5% stop, 20 days low), and by implication are parametric (which is not a good thing, as I have explained here). On the other hand, Dow Theory stops include three elements: Time, extent and confirmation (another index should confirm), and its level is not set at a predetermined level (one can have Dow Theory stops ranging from a meager 3% to 10% or even more), as their level adapts to market conditions.  More about Dow Theory stops, and the importance of the time and extent elements, here and here.

Trends for US Stocks, Chinese Stocks, Gold, Silver, their miners ETFs and US debt

If I look at all these markets through Dow Theory spectacles, I see that primary and secondary trends have not changed.

Hence, what I wrote on June 18^th, remains fully valid:

http://www.dowtheoryinvestment.com/2015/06/dow-theory-update-for-june-18-chinese.html

 

Sincerely,

The Dow Theorist

Dow Theory Update for June 18: Chinese stocks are undergoing a (bearish) secondary reaction

Trends unchanged.

US stocks:

The ranging continues, and with it, trends have not changed. Thus, as per my reading of the Dow Theory, the primary and secondary trend remains bullish. Here you can find the latest in-depth explanation, which remains fully applicable to current market conditions:

http://www.dowtheoryinvestment.com/2015/05/dow-theory-update-for-may-18-primary.html

I say that the secondary trend remains bullish, which is tantamount to saying that no secondary reaction has been signaled yet. Here you find a deeper explanation as to the non-existence of a secondary reaction, which is also a good primer on appraising secondary reactions:

http://www.dowtheoryinvestment.com/2015/06/dow-theory-update-for-june-10-nuances.html

Chinese Stocks

Is headwind for US Stocks coming?  Chinese stocks are undergoing a secondary (bearish) reaction against the primary bull market. Please have a look at the chart below:

Orange rectangles on the right side of the charts highlight ongoing secondary reaction

HAO made on two occasions higher highs which were not confirmed by FXI (highlighted by blue ellipses). Such a non-confirmation tends to be harbinger of a trend change of, at least, secondary proportions.

FXI has retreated -10.85% off its last recorded closing highs, whereas HAO has retreated -9.27%. I have performed my volatility adjustments (i.e. 50 days volatility comparison with the SPY) and without any doubt such a movement more than exceeds minimum volatility thresholds (set by Rhea and Schannep at 3% for US indices). Hence, the extent requirement for a secondary reaction has been amply met. Even under a Rhea/Classical Dow Theory viewpoint, the current decline has retraced more than 1/3 of the last primary bull market swing (counted from the lows of the last completed secondary reaction).

Furthermore, the time requirement has also been amply met, as it is evident from just a cursory look at the charts that both ETFs have been declining for more than 8 trading days each. 

From now on, we have to look at a rally of ca. +3% (assuming volatility does not change much) in at least one of the two ETFs. Once this rally occurs, Chinese stocks will have completed a primary bear market set up. We are not there yet.

So, the primary trend remains bullish, and the secondary trend is bearish (secondary reaction).

GOLD AND SILVER

The primary trend is bullish as explained here.

The secondary trend turned bearish on February 6^th, 2015 (secondary reaction against the primary trend) as explained here.

The setup for a primary bear market signal was completed on March 24, 2015 as explained here.

Thus, now:

a) Either the primary bull market closing highs 01/22/2015 are bettered in which case the primary bull market will be reconfirmed.

b) Or the secondary reaction lows are violated in which case a primary bear market will be signaled.

We have to wait and see.

Gold and Silver miners ETFs.

As to the gold and silver miners ETFs,on 3/10/15 SIL violated its 12/16/2014 primary bear market closing low. However, GDX did not confirm. As per the Dow Theory lower lows unconfirmed have no validity, and hence we cannot declare a primary bear market. Since we cannot declare a primary bear market, the primary trend remains bullish. Furthermore, the GDX and SIL staged a rally that set them up for a primary bear market signal on March 24, 2015 as explained here.

Thus, now:

a) Either the primary bull market closing highs 01/20/2015 are bettered in which case the primary bull market will be reconfirmed.

b) Or the secondary reaction lows (or the primary bear market lows of SIL, and secondary reaction lows of GDX) are violated in which case a primary bear market will be signaled.

Once again, we have to wait and see.

US DEBT

As to US debt, a primary bear market signal was signaled on June 3rd, 2015. All price action from June 3^rd remains bearish, and hence both the primary and secondary trend for US debt remains bearish.

Furthermore, the brand new primary bull market for the EUR is no good omen for US debt. The primary and secondary trend for the EUR (and CHF) remains bullish.

Here you have the details:

http://www.dowtheoryinvestment.com/2015/06/dow-theory-special-issue-us-bonds.html

Sincerely,

The Dow Theorist