Saturday, October 24, 2015

Dow Theory Update for October 24: Is the current primary bull market signal for US stocks doomed to fail?

Trends for stocks, gold silver and their miners unchanged.

I have not posted in the last few days for the following reasons:

a) I was traveling so time was extremely scarce

b) Trends have not changed. 

c) I am re-reading Schannep’s book for the 10th time. I am in a period of introspection unearthing more jewels from this masterpiece.

During the last few days, I have received feedback from some readers of this Dow Theory blog who seem to be skeptical as to the current primary bull market signal for US stocks. The main argument is that we are in the midst of an aging bull market (stocks have basically gone up since 2009) and hence there is not so much free room left for the upside. So, according to many, we ought to disregard the primary bull market signaled that was signaled on October 7 (more about the signal here and here)

Well, here comes my answer:

It is highly dangerous to outsmart Dow Theory signals. Bull markets last longer than expected. Should a Dow Theory a primary bull market signal flashed in 1998 be disregarded because the bull was already raging since the start of the nineteen nineties? We really don’t know what particular outcome a particular signal will have. We roughly know that ca. 30% of the buy signals are failed signals. However, we also know that our winners (a 70% possibility, average winning trade ca. 33%) greatly exceed our losers (a ca. 30% possibility; average losing trade ca. -6.48%). More about odds and calculations here. All in all, it is a dangerous game to try to outsmart each particular signal.

However, for those still unconvinced, who feel that the stock market is due for a big fall, and that no tailwind will help the current buy signal, I would like to make the following observations:

We should bear in mind that specific Dow Theory signals occur within cyclical bull and bear markets. The cyclical bull and bear market may last as little as less than one year or as much as eight years (in the case of bull cycles). Schannep has achieved the best definition of a cyclical bull market: When from the bottom of a cyclical bear market both the S&P 500 and Industrials rise by more than 19%, we are under a cyclical bull market. Conversely, when the S&P 500 and the Industrials decline by more than 16% we are under a cyclical bear market. More details as to why these specific percentages, under Schannep’s book, “The Dow Theory for the 21st Century" (pages 53 and seq.)

The current cyclical bull market started on October 3rd, 2011 (you can find the whole cyclical bull/bear market record on Schannep’s web “”) and has not been interrupted by a decline exceeding 16% (which would have met the definition of a cyclical bear market). Thus, the current cyclical bull market is four years old.

You might think that a four years-old  cyclical bull market has all odds staked against its further progressing. However, this is not the case. If we are to judge according to the empirical evidence compiled by Schannep (page 55 of his book), cyclical bull markets aged four years have a 50% probability of reaching its fifth year. So we cannot talk of either headwind or tailwind. The current Dow Theory primary bull market signal has been signaled within a cyclical bull market that has a 50% possibility of lasting another year. Furthermore, the average advance on that additional year averages +31.9%. 

Let’s dig further. What are the odds for the current bull cycle to last just another six months? Well, since the odds for lasting another year are 50%, we can confidently say that there is approximately a 75% possibility for the current bull market to “survive” some six months. And what about the extent of the advance? A 15% advance does not sound illogical (ca. ½ of the average advance for one year).

And here things get interesting. Since the Dow Theory primary bull/bear market signals tend to be ca. 5-7% from the bottom/top, a +15%  advance would imply that the current “buy” signal has good odds (ca. 75%) of being a successful trade. By the way, 75% which is the figure derived from the probability for the current cyclical bull market to last some extra six months, is quite similar to the average probability for each Dow Theory signal to be a winner (70%).

According to Schannep, the average advance during the fourth year of a bull market is +19.4%. However, the 12 months from October 2014 to October 2015 are far from yielding such a percentage return. Furthermore, our Dow Theory buy signal was signaled well below the highest highs of the year. In other words, if the cyclical bull market were to last just some 6 extra months, and given that we bought very near the lows of 2015, there would be significant tailwind for a decent return. The primary bull market signal was signaled at a level quite close to that seen at the beginning of October 3, 2014. Since we know that the average annual advance from that date “should” have been ca. +19.4%, we know that, if the cyclical bull market is to survive it “should” catch up, as the last 12 months have been mostly flat. If we add +19.4%  (“due” for 2015) and +ca 15% (average advance to be expected in the next six months), we are talking of considerable tailwind for the current primary bull market signal.

Please mind that even a modest ca. +10-12% advance from the August 2015 lows would result in our current Dow Theory buy signal being a winner (ca. 5-6% “lost” when buying, as we don’t buy the absolute bottom, and ca. 5-6% “lost” when selling as we don’t sell the absolute top). Any movement, exceeding 12% from the August lows should under normal circumstances (“circumstances” being a “normal” secondary reaction retracing ca. 5-6%, which ends up above the August 2015 closing lows) result in a winning trade.

For those still skeptical, I would like to draw your attention to pages 154-155 of Schannep’s book. Pre-election years have yielded on average a +12.2% gain and have an 81% probability of being a winning year. Since the primary bull market was signaled ca. 5% off the lows, the stock market should catch up (and it is actually catching up). Furthermore, the election year has a 78% probability of finishing higher and has averaged a +9.5% advance.

While I am highly skeptical as to such empirical measures of the probabilities, and I prefer market action (aka: Dow Theory signals) to guide me as to when to be “in” our “out” of the market, and, thus, I don’t need the crutch of statistics (which might have no forecasting power, as things might change), one thing is clear for those who tend to distrust the power embedded in the supply/demand equation discerned by the Dow Theory signals: There is no solid reason based on past statistics of cyclical bull markets to believe that the current cyclical bull market is on its last legs.

Hence, we should not try to outsmart the interplay of supply and demand, which manifests itself under the form of primary bull/bear Dow Theory signals. A primary bull market signal (with is inlaid confirmation rule) implies that supply is outstripping demand, and that’s all we need to know.

However, for doubters, is good to remind that the underlying “statistical tide” is, to say the least, not negative.

And, if, in spite of everything, it is a failed signal (a distinct 30% possibility), we have our narrow stop loss (the August lows). Therefore, we should have the courage as good traders to stick to the rules.


The Dow Theorist

Wednesday, October 14, 2015

Dow Theory Update for October 14: Primary bull market reluctantly signaled for gold and silver on October 12

However, I still don’t fully like the secondary reaction that defined the pivot point to be broken out for a primary bull market to be signaled


The primary and secondary trend is bullish as explained here and here.


On October 12, 2015 GLD finally deigned to confirm SLV, and hence a primary bull market was signaled. Both SLV and GLD have bettered their secondary reaction highs, and hence the primary trend has changed from bearish to bullish.

However, I feel leery with this signal, and for good reason. When I analyzed the secondary reaction whose closing highs were to be bettered for a primary bull market to be signaled, I made clear that it was a “weak” or “dubious” secondary reaction, since the time requirement was barely met. More about my qualms concerning the secondary reaction here.

And here you have an updated chart:

Primary bull market signaled or just we have just had our real secondary reaction?

On a closer look, I have seen that SLV did not even manage to rally for at least 10 calendar days. According to Schannep, at least two indices should rally for 10 calendar days, irrespective of the average time of trading days. While all this is not carved in stone, and Rhean himself stressed the difficulty in defining secondary reactions, I feel that maybe the latest closing highs we have seen may not be indicative of a primary bull market, but rather constitute the real secondary reaction highs. Those willing to jump the gun, may consider the primary trend as bullish (especially given that the ETFs miners, which tend to lead, are already on a primary bull market of their own). Nonetheless, those more conservative may rightfully consider that the last recorded highs determine the real secondary reaction, and from this point we should wait for a pullback of at least 3% (in volatility-adjusted terms) on either SLV or GLD. After such a pullback the joint violation of the October 12 closing highs would entail a primary bull market.

So here, there is room for two alternative interpretations, both of them legitimate: Either the last recorded closing highs signal a primary bull market; or, if we consider that the last rally did not qualify as a secondary reaction, the last recorded highs constitute the real secondary reaction from which we have to wait for the development of the primary bull market setup.



The primary and secondary trend is bullish since October 5th, 2015, as explained here.



The Dow Theorist

Friday, October 9, 2015

Dow Theory Update for October 9: The primary bull market for US stocks signaled on Oct. 7 unambiguously confirmed

Trends in precious metals unchanged

Yesterday, I acknowledged that a primary bull market had been signaled. However, I acknowledge it grudgingly, as the S&P 500 just exceeded its September 16th closing highs by a hair and the SPY was lagging behind. Based on that, I gave a list of technical reasons that might advocate for caution (namely, wait one day or two, until we see a little bit more strength). I also wrote yesterday that:

“Please mind that if either the S&P 500 had clearly broken up (either in extent, or at least “time," that is being, let’s say, three hours above the critical level) or the SPY had broken up, even by one cent, I would have honored the signal, no questions asked, and no additional technical bullshit would have been given by this blogger truly yours.”

Well, both the S&P 500 and the SPY showed remarkable strength yesterday, so my qualms and my technical bullshit give way to the Dow Theory: The September 16th closing highs have been amply bettered by all indices, ETFs, you name it. Even the lagging Transports have confirmed (and, their confirmation was not necessary under Schannep’s Dow Theory, but, of course, their confirmation lends even more credence to the new bullish market condition.

I don’t know whether this is going to be a failed signal given the somewhat pessimistic technical background I was depicting yesterday. What I know is that the Dow Theory overrides all other technical considerations, and it beats the pants off all other technical devices when it comes to determining the primary trend (1-2 years) of stocks and other assets. Yes, I wrote, “other assets," as Hamilton, one of the fathers of the Dow Theory, wrote in his book “The Stock Market barometer” that the Dow Theory may be applied to foreign stock indices and even to gold and other markets. More about Hamilton’s vital insight here.

The last recorded primary bear market closing lows of 08/25/2015 constitute our “exit” of Dow Theory stop loss. If such lows were jointly violated, a primary bear market would be signaled again. Please mind that this has been a quite narrow setup (which is good, as it contains losses, if the trade is a loser, but also bad, as we have a quite narrow stop more prone to whipsaws), as the closing lows are -6.48% below of the close of October 7th (day of the original Schannep’s Dow Theory signal).

One thing is clear: Once again, you see the ability of Schannep’s Dow Theory to detect a change of trend long before moving averages react. Currently, the S&P 500 is well below the 200 days moving average. Of course, I could be a failed signal, after all ca. 30% of the signals end up with losses, and detractors could say that the Dow Theory was too early. However, we don’t have to look at a single trade. When we look at all the Dow Theory track record (more about it here) we know that the Dow Theory is clearly superior to moving averages. It gets earlier “in” and “out” and it does it with more winning trades and containing losses much better, as explained here.

Here you have a chart depicting the current situation:

Primary bull market for US Stocks

By the way, if you look at the SPY (bottom of the chart), you may see that the primary bull market signal has been given at a level somewhat lower than that of the primary bear market signal of August 20th (red vertical arrows). This implies:

a) A hypothetical short would have made theoretically some money (I am against shorting long term for the reasons given here)

b)  For those exiting at the primary bear market signal, the re-entry price is lower, which translates into small additional profits, and superior drawdown protection, since on August 20th, nobody knew whether the decline was going to be short-lived or it was the harbinger of a big crash.


The primary trend is bearish as explained here.

The secondary trend is bullish, as SLV and GLD are in the midst of a secondary reaction against the primary bear market. Here you have a full explanation of a somewhat difficult secondary reaction.


The primary and secondary trend is bullish as explained here.

The Dow Theorist

Thursday, October 8, 2015

Dow Theory Update for October 8: Primary bull market signaled for US Stocks on Oct. 7

At least theoretically, as it has been a very dubious signal.

The S&P 500 closing high of September 16th, 2015 was 1995.31. Yesterday, October 7th, the S&P 500 closed above such a closing high by closing at 1995.83. Thus, the S&P 500 managed by a hair to exceed the closing highs of the secondary reaction, and by doing so confirmed the higher closing high already made by the Industrials on October 5th, 2015.

According to Schannep’s  Dow Theory for a primary bull market signal to occur, we just need the SPY and other index to break above the secondary reaction closing highs. Thus, even though, the Transports remain below its secondary reaction closing highs, a primary bull market has been signaled.

However, in the spirit of full disclosure, I must say that I have not acted on this signal. In other words, my short term trading remains with a “bear market filter," and the long term one remains flat, out of the market. I recognized yesterday’s signal as a valid Dow Theory primary bull market signal, but I also know that I have to exert judgment. After all, Schannep, as Rhea did in the past, in some instances knows when to “break” the rules. Thus, in January 2000 when both the Industrials and the S&P 500 made higher closing highs but the Transports refused to confirm, Schannep ignored the breakout (“Dow Theory for the 21st Century" pages 116 and 119 –note 4-). There are other such instances when Schannep exerted judgment.

So why in my private trading I am acting as if no breakout occurred?  There are many reasons which I will summarily list.

1) The SPY ETF, which is tries to reflect the S&P 500, and which I normally use for my Dow Theory readings, did not exceed the September 16th closing highs. While occasionally there may be small divergences between the two, yesterday there was a glaring divergence. On September 16th, the SPY closed at 200.18. On October 7th, the SPY closed at 199.41, that is 77 cents below the closing highs. Since the SPY is roughly ten times smaller than the S&P 500, 77 cents in the SPY is tantamount to 777 cents in the S&P 500, which equals 7.77 points for the S&P 500. Thus, we can perform the following math:

Closing high of Oct 7th: 1995.83


7.77 points (which would the S&P 500 equivalent of the difference between the SPY Sept 16th and Oct 7 closing highs)

Equals = 1988.06, which is clearly below the closing highs made by the S&P 500 on September 16th.

My gut feeling says that since many people had their eyes fixated on the September 16th closing highs, waiting to buy the breakout, there was an effort to levitate the S&P 500 price in the futures markets above the critical level. This is why:

a) it was a breakout by a hair.

b) It did not remain a long time above the critical level.

c) The SPY failed to follow suit (as arbitrage has some lagging). Here you have the chart (screenshot taken at 12:49 pm). The read horizontal line displays the critical level to be broken out. 

The SPY remains below its September 16th closing highs.

The mini S&P 500 (December contract) immediately after reaching the “higher” closing high, took a nose dive in after-hours trading, which seemed to confirm to me that the higher closing highs were somewhat frail.

Please mind that people look at the S&P 500 but in reality, they buy the SPY.

Having said all this, one thing is clear: Had the SPY exceeded its September 16 closing highs even by a mere cent, I would have acted on the signal.

2) Schannep’s technical big picture is bearish. In his last letter to subscribers he warned about a bearish crossover on the long term stochastic, a top in long term RSI, etc.

3) The stock market is short term overbought. I know that overbought conditions may persist longer than one expects, but, a pullback may develop from the current level any moment now.

4) The Transports are clearly below the September 16th closing highs. I know I don’t need three indices to confirm under Schannep’s Dow Theory. However, being confronted with a highly dubious higher closing high by the S&P 500, lack of confirmation by a less manipulated index, advocates for caution.

5) While the Dow Theory is not concerned with intra-day highs, it is worth noting that the Sept 17 highs have not been bettered (yes, intra day highs were made one day latter not on September 16th).

6) The SPY and the S&P 500 remain below the 200 and 50 days moving average, and both moving averages are currently declining. I know that the Dow Theory is more reactive than moving averages and, under “normal” signals, we do well disregarding moving averages, as we have a superior timing device (more about the superiority of the Dow Theory versus moving averages here). However, when confronted with a highly weak, both in extent and time (yes, time, the time that the higher closing high has effectively remained at that higher level, which has been negligible), the moving averages seem to be telling us: “Wait a little bit. If it is a real primary bull market, the market will continue to go up, and maybe tomorrow or the day after tomorrow you get a better quality signal”.

 7) While not strict Dow Theory I always keep an eye on the S&P500 advancing issues. Since September 30, the SPY has been edging higher, while the Advancing Issues has been declining. Such a divergence seems to suggest that the rally is petering out.  Higher highs in the index are not equaled by more advancing issues. Here you have a chart:

Advancing issues diverge from the SPY

8) Another indicator I monitor, the difference between new 52 weeks highs minus 52 weeks lows, has been slightly edging lower in the last three days, while the SPY was making higher highs. This tells me that there is no broad participation in this rally.

9) Such a lack of strength seems to be confirmed by the fact that stocks trading below the 200 day exponential moving average have made huge advances in the last few days. Are we just seen a short covering rally?

10) My misgivings about the lack of internal strength, have been confirmed by the blog of Dorsey Wright “Systematic Relative Strength." In his latest weekly recap, they noted that the bottom relative strength decile (that is the worst momentum stocks) clearly outperformed both the index and the high relative strength stocks (top decile).

9) While volume is to be taken always with a grain of salt, volume has been bearish. It increased in declines and decreased when the SPY was rallying.

10) The benefit of doubt is to be given to the existing trend (“the trend is your friend”), which is bearish.

Please mind that I am not giving you fundamental reasons for not having honored the primary bull market signal. I am not mentioning that, according to many pundits, stocks are overpriced, that according to Zero Hedge, the world is ending, etc. No: I just use as a prop technical knowledge.

Please mind that if either the S&P 500 had clearly broken up (either in extent, or at least “time," that is being, let’s say, three hours above the critical level) or the SPY had broken up, even by one cent, I would have honored the signal, no questions asked, and no additional technical bullshit would have been given by this blogger truly yours.

However, this was not the case.

Furthermore, I am practical. If I had taken the primary bull market signal, my Dow Theory stop would be lying ca. at -6.48% below yesterday’s close. This is an indeed narrow Dow Theory stop. While, this is good, since  our risk of loss is well contained, it increases the risk of a whipsaw. Hence, I say to myself: “Wait until tomorrow, or the day after tomorrow, for either the SPY to break up, or at least the S&P 500 to make a clear breakout. If I get somewhat late, I will maybe forgo 0.5% of performance (as I risk the SPY being higher than on the close of October 7th) but 0.5% is the price I willingly pay for: (1) a more confirmed trend, (2) a somewhat more ample stop, hence, less risk of whipsaw. If it is a real signal, sooner or later, I will see it on the chart. Furthermore,  I will see it at quite favorable price when compared with my Dow Theory stop. So wait.”

Furthermore, and this is very personal, my long term trading along with the primary trend does not involve buying the SPY, or any other similar ETF (i.e. equally weighted S&P 500). When I get a “green light” (primary bull market) I am interested in high momentum stocks, and as I have written above, such stocks are currently laggards. In other words, the stuff I am interested in, is in relative terms “cheap." I don’t need to rush, because high momentum stocks are not currently going to the moon. If today by the close or tomorrow I get a “buy” signal, I need not worry.

The Dow Theorist