Primary and secondary trends for stocks, gold and silver and their ETFs miners unchanged.
Travis, one reader of this blog, recently posted a
comment whereby he asked why I use daily bars instead of weekly bars to
determine what allegedly is the long-term trend. What follows is my answer, which
deserves a post of its own.
The primary bull (bear) market signals hinge on the
properly gauging the lows (highs) of secondary reaction (not just “any” low, though
significant it may look on the charts, as I have recently written here as many mistakenly believe). We also
know that the time requirement for a
secondary reaction to exist is at least 8-10 days (bars, when daily bars).
However, since for a secondary reaction to exist we also need the extent
requirement (at least a confirmed +/- 3% rally/decline), and the subsequent rally (pullback), most secondary reactions span
a much longer time far exceeding 8-10 days.
The actual signal that follows
the breakout of the secondary reaction highs (lows) may actually take several
months. The last primary bear market signal of late August 2015 is a clear
example of what I am meaning. In other words, the Dow Theory when working
with daily bars is perfectly calibrated: Signals are sparse, and it is
a far shot from following the short or even medium trend. It is wonderful to
see how the Dow Theory by using “dailies," we actually determine the
longer-term trend. Furthermore, by
using dailies and its associated “extent” requirement of 3%, we are able, while
avoiding the short and medium trend, to exit at relatively “save” levels (that
is near from the top) in most instances (at least this holds true for US
Stocks, including the latest primary bear market signal). Of course, the non-parametric nature of the Dow
Theory, plays a part in the usefulness of "dailies" in
determining the long-term trend, since the absence of a parameter (i.e. we don't give a damn whether the lows of the secondary reaction to be broken are 10 days lows or 100 days lows, since we demand additional requirements), helps us get rid of non-qualifying lows. A simple example which, I hope, will clarify
what I mean: it is not the same a breakout system (turtles-like) with just an
n-days breakout requirement traded with daily bars, that the same system with
an additional extent requirement which filters out many "n-days"
breakouts. This is the issue that plagues "breakout" systems: in
order to avoid too many signals, you have to either use "weekly"
bars, or, with "dailies," you have to use a very high breakout number
(i.e. 55 days breakout), which, nonetheless, continues to be very prone to
whipsaws due to the absence of a filtering out of non-relevant highs (lows),
which under the Dow Theory are filtered out thanks to the extent requirement, which serves to declare as the only valid lows (highs) those that qualify as secondary reaction lows (highs).
Readers, now it's up to you to cogitate all this. For me, after years of
mulling it over, this is as clear as day, but now you have to take your time until
all this soaks in.
If we were dealing with weekly bars, then we should
also adjust the minimum extent requirement. A weekly equals five trading days.
According to Brownian motion (more here on Wikipedia: https://en.wikipedia.org/wiki/Brownian_motion
), we should calculate the square root of 5 (5 days/ 1 day) in order to
ascertain our minimum movement multiplier. In other words, if when working with
“dailies” we require a minimum movement of 3%, when working with “weeklies” we should
require 3 x 2.23 = 6.7% minimum movement for a movement to be meaningful.
Furthermore, patterns are fractal, so the minimum time requirement would
continue to be 8-10 bars (formerly, “days”). All in all, our new “secondary
reactions” determined by weekly bars, would be too long term oriented. Our
primary bull/bear market signals would be flashed too far away from the top/bottom.
Thus, the 1987 crash would not have been avoided when using weekly bars, as a
way to gauge the primary trend.
However, “weeklies” may be useful as a technical means
to determine the secular trend. Let’s
make a thought exercise. If when using “dailies” a Dow Theory primary bull/bear
market signal is signaled ca. every 1-2 years, when using weeklies, we can
expect signals to be signaled every 5-10 years, which is well attuned to the
secular trend (multiplier of 5). I have some research (which will remain private for the time
being), and the longer the time frame (by using, i.e. weeklies) the less
noise, and hence the less signals. In other words, when being in a x 5 greater time frame, signals will not
necessarily be signaled x 5 slower, but rather, you may expect even them to be
signaled more than x 5 slower. Readers of this Dow Theory blog know that I am
highly skeptical as to the usefulness for the average investor of the secular
trend (more about his here and here). Having said this, if I had to rely on a
method to gauge the secular trend, it would be technical (as with Dow Theory
with “weeklies”), and certainly not, value/fundamentally based.
The use of weeklies as a way to establishing the
secular trend may be useful for certain investors in order to avoid whipsaws
when trading along the primary trend as determined by “dailies." In other
words, one could wait for the secular trend to turn bullish (as determined by “weeklies”)
in order to buy pursuant a primary bull market signal (as determined by the “dailies”).
However, be advised, that by doing so you would have missed the monster primary
bull market signal of mid-2009. If you wait to honor primary bull market
signals (as determined by “dailies”) until the secular trend (as per “weeklies”)
has turned bullish, you may avoid a few whipsaws, but you’ll miss a big piece
of the action.
By the way, if we gauge the current trend with
weeklies, we have to conclude that the secular trend remains bullish. The
current decline would qualify as a secondary reaction whose Friday, September 4th
lows have not being violated yet. Furthermore,
no setup for a primary bear market signal has occurred yet, and hence, we
cannot say that the final lows of the secondary reaction have been put yet.
Nonetheless, I would not trust my fortunes (and timing) to a bullish secular
reading, albeit such secular readings may be useful to some very long term
oriented investors. Here you have a weekly chart of the Industrials, Transports and SPY (bottom), and the ongoing secondary reaction is highlighted by orange rectangles.
 |
| Dow Theory applied to weeklies: Just a secondary reaction against the secular bull market |
Of course, the opposite holds true when applying the
Dow Theory in shorter time frames. I also have some preliminary research that
seems to prove that the Dow Theory can also be applied to lower time frame
bars (i.e. 130 minutes bars). As with “weeklies," you have to adjust the minimum
movement (which will be lower than 3%) in order to account for the lower time
frame. Theoretically, signals should be given (when working with 130’ bars) 3
times for often than with “dailies” (as 130' x 3 = 390’=one trading day=1 daily
bar), which would be ca. 1.5-3 signals per year (0.5-1 signal per year with
dailies x 3). However, given that noise tends to increase with lower times
frames, you should expect more signals, and hence more whipsaws, as the lower
the time frame, the higher the noise and non-trendiness (Nassim Taleb, in his
book “Dynamic Hedging," makes some interesting remarks concerning mean
reversion, trend and time frames).
Conclusions:
1) Daily bars are the ideal vehicle for gauging the
long term trend under the Dow Theory, and to avoid crashes like the one of 1987 or to get aboard early as in mid-2009 and not miss a new bull market.
2) Weekly bars are useful in order to gauge the
secular trend (on a pure technical basis). However, they are not the “best”
timing indicator, as it tends to be late at crucial market turnings.
3) The current “secular” trend remains bullish (a mere
secondary reaction against the bullish secular trend) when gauged on a pure
technical basis (with the Dow Theory), which may be of little consolation for
those experiencing deep losses.
4) The Dow Theory seems to work at lower time frames (i.e. with 130' bars). However, noise increases and, while still profitable, key measures like profit factor, percentage win, etc. seem to deteriorate. Further research should be conducted.
Sincerely,
The Dow Theorist
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