Dow Theory Update for August 21 (II): More about the primary bear market signaled for US stocks at the close of August 20

Some hours before, I wrote that yesterday, as per my reading of the Dow Theory (which is Schannep’s with some minor quirks) a primary bear market was signaled.

Let’s delve further into it.

Here you have an updated chart:

Anatomy of a primary bear market signal.

As you can see, on the left side of the chart, on January 15, 2015, there was a secondary reaction (orange rectangles). Such a secondary reaction was determined both by Schannep, of thedowtheory.com and I. Thereafter, the SPY (on May 14) and Industrials (on May 18) made higher closing highs, whereas the Transports failed to do so (blue arrows on the chart). As per Schannep’s Dow Theory, such a double confirmation does not suffice to declare the then ongoing secondary reaction as finished. A triple confirmation was required, and, hence, the secondary reaction lows of January 2015, remained the valid lows to observe. However, as per my own interpretation of the Dow Theory (basically: just two indices should confirm), higher highs confirmed meant that the secondary reaction of January 2015 was to be declared extinguished, the primary bull market as reconfirmed, and, thus, our “clock” set to zero, when it comes to counting days and declines in order to appraise a new secondary reaction. All this was explained here.

Some days after the higher highs, the SPY and Industrials started to decline (and the Transports extended the decline which began on 12/29/2014). On June 29, 2015, a secondary reaction was signaled, as explained here:

From the secondary reaction lows made jointly on 7/8/2015, all three indices rallied by more than 3% (the Industrials was de first one to do so), as explained here and here, and accordingly setup US stocks for a primary bear market signal (the rally is shown by blue rectangles on the right side of the chart).

On July 27^th, both the Industrials and Transports were below the secondary reaction lows. However, the SPY refused to confirm, and for the reasons explained here (and more in-depth here), we could not declare a primary bear market.

Yesterday, the SPY violated on a closing base its 7/8/2015 lows, and, hence provided the needed confirmation and with it, a primary bear market was signaled.

According to a strict reading of Schannep’s Dow Theory, a primary bear market signal has not been given yet, as (according to Schannpep) the valid secondary reaction lows to be taken into account are those of January 15, which have not been broken yet by the SPY. However, as Schannep himself has noted to his subscribers, under the “Rhea/Classical” Dow Theory, a primary bear market has been signaled yesterday.

What to do now?

Schannep himself is skeptical about the validity of the signal, as the Transports were diverging (that is after having violated its secondary reaction lows some days ago, started to go up). Furthermore, Schannep times his trades with the help of his “timing indicator," (not related to the Dow Theory) and, at best, he would only sell one-half of any hypothetical position until his timing indicator turns bearish.

It is up to each trader/investor to decide what to do. I do not pretend to know the future, much less to be a guru. I am just a private individual who tries to form his own judgment and separate the signal from the noise. Furthermore, psychological and financial risk tolerance depends on each investor’s circumstances and makeup. Investors with a very long term horizon and good tolerance for drawdowns, might wait until the January 2015 lows are violated by the SPY. Shorter term traders, might consider adjusting  their trading parameters to the new market situation (that is trading under the assumption that there is a primary bear market).

One thing is clear (at least) to me: I personally honor all Dow Theory signals and try not to make second-guessing.

So now, let’s briefly recap the outcome of the last “buy” signal.

After a whipsaw, and according to my reading of the Dow Theory, a primary bull market was signaled on October 31^st, 2015. The entry price for the SPY would have been 201.66.

The close on August 20^th, 2015 was 203.97, which is percentage wise a small win of 1.14%.

Not all trades are “stellar” trades. However, once again, we have seen that (at least for US Stocks) the Dow Theory has done a good job at containing losses. I don’t know whether the current sell signal harbingers a crash, "just" a -20% decline, or it is just a whipsaw. I don’t know. What I do know is that following a primary bear market signal (and especially when it follows a tight congestion, since it is not the same a signal after an already sizeable decline, than after months of ranging), the market is vulnerable to big declines. Sometimes they don’t occur, but when they do, losses can be devastating, and hence, the sensible course of action is to stay out of trouble.

As I wrote here:

“Experience says that ca. 2/3 of the time, a small rally follows immediately after the primary bear market signal. However, 1/3 of the time, such a rally fails to materialize, and we get an even steeper decline. The money won by not selling immediately is more than lost in the 1/3 of occurrences when a collapse follows a primary bear market signal (i.e. 1929 and 1987 crash among other instances).

Bottom line: One must react as soon as possible once a primary bear market signal has been flashed.”

 

So now, it is a good moment to be sitting on cash (which cash, that’s another issue, as the primary bull market for the EUR, in spite of a recent correction, has not been reversed), and patiently wait for the next primary bull market signal.

Precious metals Universe

Both gold and silver and their miners ETFs are close to signaling a bullish secondary reaction against the primary bear market. However, as of this writing, the primary and secondary trend remain bearish as explained here.

Sincerely,

The Dow Theorist