Friday, November 11, 2016

Dow Theory Update for November 11: The current trend as per the classical/Rhea Dow Theory (III)

Alternative (and truest ) "classical" interpretation as per Page 77 of Rhea’s book “The Dow Theory”

Please mind that I am writing before the close. Things might change.

In the past two post I analyzed the trend as per the classical/Rhea Dow Theory. The first post showed Schannep’s interpretation (not of his own “Dow Theory” but the “classical” according to him). According to this reading the primary trend was bullish since 9/7/2016.

The second post gauged the trend with the stricter reading followed by other Dow Theorists (three weeks at least for a secondary reaction to exist). According thereto, the primary trend was bearish as the Industrials had failed to break up their secondary reaction highs. Update: Recent past action by the Industrials resulted in their breaking up their secondary reaction highs, and hence confirming the Transports and accordingly signaling a primary bull market on the close.
However, there is a third way to apply the Rhea/Classical DowTheory which would have signaled a primary bull market in stocks on October 5th, 2016. According to Rhea (“The Dow Theory”, page 77 Fraser Edition), “when a series of such rallies and declines have penetrated the highest points previously attained in a primary bull market, it is generally safe to infer that the primary bull trend will continue for a considerable period of time”

If you look at the chart below you will see that a primary bear market was signaled by the Classical/Rhea Dow Theory on June 24th, 2016.

A primary bull market signaled on October 5th, 2016: Last recorded primary bull market highs broken out

The primary bull market highs were made on 4/20/2016 by the Industrials and Transports. Thereafter, a secondary reaction developed (more than three weeks of declining prices) as shown by the red rectangles. A rally (blue rectangles next to the orange ones exceeding 3% set up stocks) for a primary bear market signal. The secondary reaction closing lows were jointly violated on 6/24/2016, and hence a primary bear market was signaled (red arrows).

Following the primary bear market signal a rally set in. If we are to strictly apply the  “Rhea/Classical” Dow Theory no secondary reaction formed until 9/8/2016 (when the Transports finally deigned to confirm the Industrials' rally). Thereafter, there was a pullback exceeding three percent which set up stocks for a primary bull market signal. The Transports broke up their secondary reaction highs on September 30, 2016 fully unconfirmed by the Industrials, and hence no primary bull market existed on that date and in the following days (until 11/11/2016 when the Industrials finally broke up above their secondary reaction highs. The chart below displays the situation described on this paragraph.

Secondary reaction, pullback and subsequent break up (bull market signal) if we were to declare signals based exclusively on secondary reactions (hence ignoring the breakup of the last recorded primary bull market highs)

The takeaway from is clear: No primary bull market signal would have been signaled until 11/11/2016 if we were to appraise the Dow Theory exclusively based on the breakout of secondary reactions.

However,  if we go back to Rhea’s book, the breakup of the last recorded primary bull market closing highs constitutes a valid primary bull market signal. In other words, we don’t have to wait for a secondary reaction to develop (or for its closing highs to be broken out) in order to declare a primary bull market.

Please look again at the very first chart of this post (scroll up!). The red horizontal lines display the highs of the last primary bull market. On 7/8/2016 the Industrials broke up above their last recorded primary bull market closing highs. The Transports, though, did not confirm. On 10/5/2016 the Transports finally confirmed, and hence, according to this interpretation of Rhea’s Dow Theory a primary bull market was signaled.  Blair Wagner writing for “Downside Hedge” punctually signaled the existence of a primary bull market on October 5th, 2016. While he did not elaborate as much as I do, the diagnosis was fully right.

Thus, any way you cut it, according to the “Rhea/Classical” Dow Theory the primary trend is bullish.

On the other hand, according to Schannep’s Dow Theory, the primary trend is bearish, as was reported here.

If the SPY (SP500) manages to break up its last recorded primary bull market closing highs of 8/15/2016, then the primary trend would turn bullish as well. Hitherto, both the Industrials and Transports have done so. However, as per Schannep’s Dow Theory we need triple confirmation for a new primary bull market to be signaled.

I insist that we are living highly noisy (lack of a clear trend) and volatile (repeated ups and downs) market. Hence, it is no surprise that there is no unanimity when it comes to applying the “classical” and “Schannep’s” Dow Theory. Eventually, though, both will be in unison. Please mind that it is fully normal for both Dow Theories to occasionally disagree. Otherwise, they would be the same thing and there would be no way for Schannep’s Dow Theory to build its outperformance versus the classical Dow Theory (more about the Schannep's Dow Theory outperformance here)

The Dow Theorist

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