Wednesday, December 16, 2015

Dow Theory Special Issue: Additional thoughts concerning further declines following Schannep’s Dow Theory primary bear market signals

Updated statistical record

Last Friday 11th a primary bear market was signaled for US stocks. More about the entrails of this primary bear market signal here.

I wrote that investors better heed primary bear market signals as determined by Schannep’s Dow Theory, as the statistical record compiled by Schannep in his book (page 108) makes clear that the average further decline following a primary bear market signal is 14.6% over 5.5 months. Using average figures is misleading, as such an average contains monster bear markets with subsequent declines exceeding -40%.  My take away was clear: Don’t outsmart primary bear market signals. Be disciplined and act on them.

However, Schannep’s compiled statistical record finishes in year 2004. Hence, I decided to update such a record with the primary bear market signals which have occurred after 2004 to date (which includes the brief primary bear market signaled on August 2015).

“On average” things have not changed much when we update the record. The average further decline following the primary bear market signal amounts to -12.97 % over ca. 4.2 months. So things have not changed much.

Here you have my spreadsheet:

Updated record: Subsequent decline following primary bear market signal and time to final low

Furthermore, the updated record contains the monster bear market of 2008-2009 when we saw additional declines following the primary bear market signal of -42.49% (2008) and -18.08% (2009).

The market environment following 2009 has been clearly bullish. Hence, we see that some of the primary bear market signals were followed by more modest declines. Even in two instances (2011 and 2012) the day of the primary bear market signal was the date of the primary bear market low. In other words, there was no subsequent decline, and hence the next “re-buy” (primary bull market signal) entailed buying at a slightly higher price. However, even under a persistent upward bias, the investor was very well protected by following all primary bear market signals.

Curiously enough, as I write these lines (market open of December 16th) I see a torrid rally going into its third day that might entail a failed primary bear market signal. However, we should be disciplined and know that in real time nobody knows the outcome of a particular signal and that, on average, we are well served by not trying to outsmart each signal. The updated statistical record shows that following a primary bear market signal the odds clearly favor more declines, and in some instances, huge declines.

The Dow Theorist

1 comment:

  1. June 24th, 2016 update:

    The “torrid rally” I was referring to in the last paragraph of my post, eventually fizzled out. It did not even manage to change the secondary trend, and the SPY further declined until February 11th, 2016. The total decline following the primary bear market signal of December 11th, 2015 until the final bear market lows amounted to -9.11%, once again confirming that primary bear market signals are to be heeded (unless one has the financial and psychological fortitude to endure big drawdowns. However, don’t overestimate your ability in real time to tolerate drawdowns as explained here

    The Dow Theorist