Monday, December 14, 2015

Dow Theory Update for December 14: Primary bear market signaled for US Stocks last Friday 11

Precious metals trends unchanged.


I am writing at the open of December 14. I refer to the price action seen last Friday 11 at the close.

My Dow Theory Update of last December 9th warned that US Stocks were flirting with a primary bear market signal. I pointed out that the Transports had made a higher high unconfirmed, which is a yellow flag. Later on, the very same Transports violated their secondary reaction lows. We just needed confirmation for a primary bear market to be signaled. Such a confirmation came last Friday when the SPY (and the S&P 500) clearly closed below its 11/13/2015 closing low. According to Schannep’s Dow Theory, a primary bear market was signaled, as we don’t need confirmation by the three indices. If I were just following the “classical/Rhea” Dow Theory, no signal would have been issued, as the Industrials remain above their secondary reaction closing lows. 

Here you have a chart showing the situation last Friday 11. The horizontal red lines (secondary reaction lows) have been violated by the SPY and Transports, and hence a primary bear market signal has been signaled. 

Primary bear market signaled on Friday 11th.

I don’t know whether this is going to be a “failed” signal (namely, the next “buy” signal is above the price levels seen on December 9th) or the markets are going to start going down in earnest. Rhea made clear that neither the extent nor the duration of a Dow Theory signal can be forecasted. We just take what the market gives us. However, experience has taught me that even a “failed” signal is not so “failed” after all, since a “re-buy” at a higher level is less risky that “holding and hoping” under the current technical juncture. The stock market is technically on a stronger foot after a primary bull market signal than right now when the secondary reaction lows have just been violated. We should not forget that all market crashes have been preceded by a primary bear market signal. I am not saying that all primary bear market signals end up in crashes. However, all crashes were preceded by a weak technical condition (primary bear market signal).

All in all, I rather prefer a “re-buy” even if this implies a worst-case higher price of ca. 3% (this is the confirmed price advance we should see from the current lows for a new primary bull market to be signaled, namely the breaking out of the last primary bull market highs –November 3rd for the SPY and Industrials-) than hoping now for the best and risk a serious loss (with crash or without it) which is the “average” normal consequence of a primary bear market signal.

Furthermore, in most instances, the next primary bull market signal occurs at a level lower than the current exit price (as we saw with the primary bear market signal of August 20th this year when the subsequent primary bull market signal of October was signaled at a slightly lower entry level). So why overstay a trade? Stay out until there is tailwind.
For doubters as to the “power” of Schannep’s Dow Theory primary bear market signals, is good to recall page 108 of Schannep’s book “The Dow Theory for the 21st Century”. The average further decline following a primary bear market signal is 14.6% over 5.5 months. However, averages are misleading, as in many instances the decline that followed exceeded -20%. So, while it is true that every now and then there are “failed” signals (that is the “re-buy” comes at a higher price level), truth is that the odds are against ignoring the forecasting power of a primary bear market signal as determined by Schannep’s Dow Theory. If we are to survive long-term in the stock markets, it is vital to learn to cut losses short (or not to let a winning trade turn into a loser). Minervini (a real stock market genius), gives conclusive evidence as to the need of keeping losing trades small (pages 301-311 of his excellent book "Trade Like a Stock Market Wizard"). This is why Schannep's Dow Theory has much better odds when looking forward (+115 years Dow Theory track record could be not so long, after all) of keeping investors safe (not "blow up") than many other long term trading systems (classical Dow Theory included). By its own structure (definition of secondary reaction), it is likely to signal exits very close to the top or entry price, thereby keeping losses below the critical -10% level.

As to this specific "exit" (primary bear market signal), our exit level lies above our entry point. The primary bull market signal was signaled with the SPY at 199.41 while last Friday 11 it closed at 201.88. While this is a negligible profit (very likely partially eaten up and rendered “break even” by slippage and commissions), the Dow Theory is helping us keep our powder dry in those suboptimal trades. I repeat: We just take what the market gives us.

A further and final thought: As written above, our “worse-case” scenario is an uninterrupted rally that jointly breaks out above the last recorded primary bull market highs, and thereby flashes a new primary bull market. In such a case, we would be re-buying at a ca. 3-4% higher price. However, please mind that Schannep’s Dow Theory manages to signal exits (primary bear market signals) very close to the top. This has two beneficial consequences for the investor: (a) it helps us “cut our losses short”, and (b) In case it was a “failed” signal our re-buy level is close enough. The 3-4% “lost” by having to buy at higher price levels is to be seen as a small insurance premium paid today against the risk of a serious decline, which as I have shown, statistically is the most likely outcome. All in all, today, in real time, I am willing to pay a small premium (namely, being forced to “re-buy” at ca. 3-4% higher price) for the protection I get in most instances of avoiding an average further decline of 14.6%.

If someone is thinking that Schannep’s tight stops (primary bear market signals) are likely to result in more whipsaws or degrade performance, my answer is a clear: NO. Schannep’s Dow Theory doesn’t have a larger share of losers (as when compared to the classical/Rhea Dow Theory) and it outperforms the “classical/Rhea” Dow Theory). Here you find an in-depth study backing my claims.

I feel I cannot make a more persuasive case concerning discipline, not outsmarting signals and honoring our stops.


The primary and secondary trend is bearish as explained here.


The primary trend remains bullish as explained here.

SIL has violated its 9/10/2015 closing low (last primary bear market low) unconfirmed by GDX. Both ETF miners are under a strong secondary reaction (displayed by the red rectangles on the chart below).

We have to wait for GDX to confirm. Until then we cannot declare a new primary bear market. The longer it takes for GDX to confirm, the better the odds for the primary bull market to survive. However, price action is king.


The Dow Theorist

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