Friday, November 4, 2016

Dow Theory Update for November 4: The current trend as per the classical/Rhea Dow Theory (I)

Schannep's interpretation

In my last post I wrote that there are diverging opinions when it comes to determining the primary trend according to the “Rhea/Classical” Dow Theory.

The starting point where, it seems, there is unanimity is a primary bear market which was signaled on 6/24/2016.

Disagreement begins when it comes to gauging the existence of secondary reactions. If we strictly stick to the three weeks’ time requirement for a secondary reaction to exist, then we are still under the very same primary bear market which was signaled on 6/24/2016.

If, on the other hand, we accept (as Rhea did) that two weeks may occasionally be enough to declare a secondary reaction (provided the extent requirement is met), then we have to conclude that the rally that followed the 6/27/2016 closing lows qualified as a secondary reaction.

Look at the charts below:

The trend is bullish as per the Classical/Rhea Dow Theory as interpreted by Schannnep

The blue rectangles display the rally that started off the 6/27/2016 closing lows. The Industrials rallied for 16 trading days, whereas the Transports did it for only 12 trading days. Thus, the Transports felt short of 15 trading days (or three weeks). However, unambiguously the Transports rallied more than 2 weeks. If we are somewhat flexible (or merely we heed what Rhea wrote) and accept that 2 weeks may be enough to declare a secondary reaction, then the rally highlighted in blue is a true secondary (bullish) reaction against the then existing primary bear market as determined by the classical Dow Theory.

Following the secondary reaction closing highs there was a pullback. The Transports declined more than 3% (not the Industrials), and hence setup stocks for a primary bull market signal. It bears repeating that the decline that follows the secondary reaction need not be confirmed as far as the extent requirement is concerned. More about these nuances vital to the proper interpretation of the Dow Theory here.

On 8/11/2016 the Industrials bettered their 7/20/2016 closing highs. The Transports lagged and confirmation came on 9/7/2016, thereby flashing a primary bull market signal.

As of this writing, no secondary reaction against the primary bull market has occurred. The Industrials have fulfilled the time and extent requirement. However, the Transports have failed to do so, as they have continued making higher highs and the decline following the last recorded highs (orange rectangle on the right side of the chart) has not exceeded 3%. Thus, there is lack of confirmation which is tantamount to no secondary reaction. Absent a bearish secondary reaction against the primary bull market, it is clear that we are still are miles away from a primary bear market setup. Hence no sell signal has been given by the classical Dow Theory as interpreted by Schannep. 

The chart above also show the development of a line (a confirmed narrow range not exceeding 5% on both indices). Such a line has been broken by the Industrials on November 2nd. However, the Transports have not confirmed which implies that for practical purposes the line has not been broken and hence we cannot infer a change of trend (not even of secondary character). Thus, according to the classical Dow Theory as interpreted by Schannep, the primary and secondary trend remains bullish. 

By the way, here I wrote why under Schannep’s Dow Theory we don’t use lines and why there are not necessary and gave ample explanations as to their importance when applying the Rhea/classical Dow Theory. 

However, as this blog has made clear countless times, I live and die by Schannep's Dow Theory, and, hence, while it is instructive to discern the trend as per the "Rhea/classical" Dow Theory, I personally heed Schannep's Dow Theory for my own trading activities. If still unconvinced about the superiority of Schannep's Dow Theory, please go here.

Soon I will discern the trend when strictly applying the Dow Theory without allowing for secondary reactions of less than 2 weeks (that it demanding at least 3 weeks confirmed). Moreover, I will analyze another alternative interpretation based on a quite hidden sentence to be found on page 77 of Rhea's book "The Dow Theory" (Fraser Edition 1993).

The Dow Theorist.

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