Thursday, January 14, 2016

Dow Theory Review for 2015

US Stocks

Let’s briefly recap how our Dow Theory analysis fared in 2015. Did we do a good job at determining the primary trend of the markets? 2014, as explained here, was a good year for those applying the Dow Theory to stocks, gold, silver and their miners. 2015 has been a good year too (by avoiding losses with losers).

Today I focus on US stocks. In the coming days, I will review how gold, silver and their ETF miners fared when traded in pursuance with the Dow Theory.

The year began on January 2 with an ongoing primary bull market (more about it, here)

This primary bull market signal lasted until August 20th, when a primary bear market was signaled, as explained here and here.

Following the primary bear market signal, the SPY further declined  -8.18% until a bottom was made on 8/25/2015. Please mind that my reading of the Dow Theory slightly diverged from that of Schannep. Schannep signaled the primary bear market one day later, on 8/21/2015, and hence, the subsequent decline until the bottom amounted to only -5.24%.

For the sake of clarification I must say that I signaled the primary bear market one day earlier that Schannep because I had identified a secondary (bearish) reaction against the then ongoing primary bull market in a different fashion than Schannep (I considered the primary bull market reconfirmed with just confirmation from the Industrials and the SPY; and from such higher highs I appraised the development of a secondary reaction, whereas Schannep, by requesting confirmation by the three indices of the all-time highs, did not appraise a new secondary reaction, and had to wait until the traditional Dow Theory signaled a primary bear market signal. Yes I know it is kind of esoteric, and I hope one day I have the time to further dissect such nuances of Schannep’s Dow Theory). In the spirit of full disclosure I must say that if I were to apply Schannep’s Dow Theory right now, I would have done it in exactly the same way than Schannep. Hence, I don’t want to boast that I was one day earlier or smarter than Schannep. It was mere luck, because further study of Schannep’s Dow Theory proved me that Schannep’s requirement of confirmation by three indices in order to consider the primary bull market reconfirmed (when breaking out above last primary bull market highs), is a very sound requirement, which I plan to respect to the letter in the future. In past instances (i.e. 1999 and 2007), and specially within aging bull markets, Schanneps’ requirement of demanding all three indices to confirm higher highs, resulted in avoiding false signals, and kept investors on the right side of the market.

On October 7, 2015 a primary bull market was signaled, as explained here and here.

Please mind that the entry price was at a slighter lower level than the previous exit price, which is good.

It was a short-lived primary bull market, though, as a primary bear market signal was signaled on December, 11th 2015, as explained here.

Please mind that the exit price (SPY at 201.88) was at a slightly higher level than the entry price (SPY at 199.41). Thus, even though it was not an outstanding signal (in the sense that it didn’t bear much fruit), it was certainly not a loser. The pattern of Dow Theory trades resembles that of trading: Most of the trades tend to be small winners or losers; however, every now and then we stumble on a big winner (2013-2014 comes to my mind). There is nothing wrong with small winners provided the losers are kept under control, something which the Dow Theory manages to do remarkably well.

Here you have a chart displaying 2015, from January 2nd (first trading day) to December 31st. The orange rectangles displays the periods we were sitting on the sidelines due to primary bear market signals.

The Dow Theory kept investors on the safe side during 2015

Now let's have a look at profits, as shown in the spreadsheet:

Please mind that the real profits made by the investors are those that I label "capitalised". This is the money you'd have made starting with 100 units, cashing out 98.84 units at the August 20 exit (-1.16% loss) and reinvesting the 98.84 units at the buy signal on Oct 7, and exiting on December 11 (+1.23% profit) for a total gain of 0.056%. As you can see the Dow Theory managed to remain (barely) positive, while buy and hold lost -1.21% during 2015.

Thus, the Dow Theory outperformed buy and hold by +1.27% in 2015.

As I explained here, the Dow Theory tends to outperform “buy and hold” when the going gets tough. In good times, there is no need for “timing” as a rising tide lifts all boats. 2015 was a tough year, though, with sideways movement punctuated by sharp declines and recoveries that is noise, which tends to kill traders)
While Schannep’s Dow Theory managed to outperform by and hold by almost 1.27% in 2015 (which is no meager accomplishment, given the deflationary environment), we should adjust total returns by taking into account the maximum drawdown suffered during 2015. If we do so, then we see the net superiority of the Dow Theory over buy and hold, as such an outperformance came with less risk. As you will see on the spreadsheet below, when we adjust for risk, we sew that buy and hold had a maximum drawdown of -12.28% versus  a mere -4.44% for the Dow Theory. From these figures we can draw two conclusions:

 a) The obvious one: The Dow Theory manages to contain losses, and to keep investors on the safe side (cash) when bullish trends subside. It had a maximum drawdown almost three times smaller than that of buy and hold.

 b) The Dow Theory (especially, Schannep’s one), manages to signal the change of the primary trend very close to top. It is highly reactive. The two largest drawdowns  experienced by the Dow Theory during 2015 which coincided with two “sell” (primary bear market) signals occurred at less than 5% from the top.

MAX  Drawdown 2015  SPY buy and hold
MAX  Drawdown 2015  SPY Dow Theory


Closing high
Closing high
Closing low

Max Drawdown

Max Drawdown

Closing high


Max Drawdown

Conclusion: the Dow Theory did a good job keeping us all year long on the right side of the market. Out of 12 months, the Dow Theory had us invested in the market roughly 10 months. The first primary bear market signal helped us avoid a major scare (the August mini crash), while the second one of December is helping us right now (January 8 as I write) from another steep decline. 


The Dow Theorist

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