Tuesday, March 5, 2019

Dow Theory Update for March 5: Cyclical bull market for US stocks signalled on March 1st.


 Precious metals remain in primary bull market


I am writing before the close. I am traveling and I cannot post charts. Today is going to be a dry post.

This post was supposed to be the first post on “capitulation” one of Schannep’s tools in his trading toolbox. However, the new “cyclical” bull market signal forces me to devote my time to this matter. However, it is a good occasion to further season our knowledge of Schannep’s Dow Theory. So it will not be time lost for any of us.

US STOCKS

The primary trend as per Schannep’s  Dow Theory is bullish since March 1st, 2019 when both the Industrials and the S&P 500 closed at +19% from the 12/24/2018 bear market closing lows. The secondary trend is bullish too, as explained here.


Please mind that the “typical” setup for a primary bull market signal has not been completed. As a reminder, we need for the “typical” signal, a secondary reaction against the primary bull market (we had it), a pullback on a least one index exceeding 3% (has not been hitherto met) and a subsequent confirmed breakout above the secondary reaction closing highs.

However, as I explained in my previous post, Schannep’s Dow Theory avails itself of the “cyclical” bull market definition in order to change the trend form bearish to bullish as well. If the cyclical bull market definition is met, then we have a new bull market, which also entails a primary bull market. I quote from my last post:

“One of the rules of Schannep’s Dow Theory states that cyclical bull market will be signaled if both the Industrials and the S&P 500 rally more than 19% off the primary bear market lows. In this case, the relevant levels to be attained are 25,932.62 for the Industrials and 2,797.81 for the S&P 500. Please mind that I have written “cyclical bull market” and not “primary bull market”. Cyclical bull markets tend to last more time on average than primary bull markets. Thus, a cyclical bull market may engulf two or three primary bull markets. As I have just written, a cyclical bull market is signaled when both the Industrials and the S&P 500 rally more than 19%. Conversely, a cyclical bear market is signaled when both the both the Industrials and the S&P 500 decline more than 16%. More about cyclical bull markets here and here
 
When a cyclical bull market is signaled, we should heed the signal even though we have not got the typical primary bull market setup consisting of (a) secondary reaction; (b) pullback and (c) breakout above the secondary reaction closing highs.”

I must confess that my first feeling upon seeing the new bull market signal was one of annoyance. Yes, I got a dizzy feeling, as the signal was being given at a +19% off the market closing lows of 12/24/2019. Well, that was not exactly catching a bottom, and, under these circumstances I usually tend to think that the run up is coming to an end. In other words, that a reversal and failed signal is at hand.  Of course, it is nicer to get a “traditional” primary bull market signal at an average level of ca. +9% of the primary bear market lows. However, the market does not always oblige. On the other hand, a signal given at +19% off the primary bear market lows, is more likely to be more  reliable than another one given at just +9% off the primary market lows. Don’t forget that momentum begets momentum (up to a limit), so while a +19% buy signal may look scary (and it does) we should stay rational. Schannep has studied this aspect, and a rally of +19% has more likelihood to continue than a meager rally.

However, I feel that three remarks are pertinent in order to calm ourselves:

Firstly, as Schannep explains in his email of March 3rd, 2019 to subscribers, the average first year gain for all bull markets (“cyclical” ones) since 1900 has been sizeable, well north of 40%. I don’t want to give the exact figure right now, as this is information which has been given to subscribers. However, if the past is to serve us as a guide (please mind: no guarantees!), honoring this signal is more likely than not to result in profits. There is still a lot of powder dry to power this market upwards.

The public area of Schannep’s website contains more information so that those faint of heart become emboldened and trust  such  “cyclical” bull market signals:

I quote Schannep:

My own studies of the stock market in the 20th century show many fluctuations of 10 or 15% that don't develop into anything, but when markets bounce up 19% that is the threshold from which advances have then risen 93% of the time to over +29% (emphasis supplied)”

Under this link, Schannep’s provides a lot of useful information for free concerning the extent and longevity of “cyclical” bull markets. Most of the time, a “cyclical” bull market means a persistent rising tide. A “cyclical” bull market has a median duration of 25.4 months and a median extent of 74.1%. Please mind that I am not implying that the “cyclical” bull market will not undergo a primary bear market. This will happen in most cases. So it is perfectly possible for us to see in the coming months a primary bear market which, nonetheless, does not extinguish the "cyclical" bull market, which implies a primary bear market which from bottom to top does not exceed -16% on both the Industrials and the S&P 500.


Secondly, the risk (amount likely to be lost) on this trade is not 19%. Even though the “buy” signal has been given at a lofty level, our risk is not 19% (barring a sudden overnight market crash. Once again: no guarantees!). Thus, we have several alternative exits. First of all, let’s assume that the stock indices stall and a secondary bearish reaction against the primary bull market gets started. We know that on average primary bear market signals (our exits) are given within 7.7% of the tops (please see this post)


Hence, more likely than not, our risk for this trade should be at a level of 7-8%.

But, what if, the indices refused to produce a primary bear market setup, and we got continuously falling prices. Well, in this case, the “cyclical” bear market definition would come to our help. More about it here. If both the Industrials and the Transports declined more than 16% from the last recorded top, a “cyclical” bear market would be signalled which is also a valid exit signal. Of course, this implies a risk in the vicinity of -16%, but on most occasions (I don’t have the exact figure at hand) a “normal” primary bear market signal develops before we get the “cyclical” bear market signal. If one feels totally uncomfortable with the open risk, one can always make a smaller commitment (i.e. 50% of the available trading funds) so that our total risk for the portfolio is halved.

Thirdly, if one were properly and consistently applying Schannep’s Dow Theory, one would have already opened a position consisting at least of 25% of the available trading capital on 12/24/2018. On that date we had capitulation and as per Schannep’s rules, at least 25% of the funds should be committed to the long side. In other words, the average entry price (25% of the funds invested at the very bottom of 12/24/2018 and 75% of the funds invested at ca. +19% of the bottom) results on an average entry price lower than 19% of the bottom, which also serves to reduce the risk of the trade, as the 25% invested on 12/24/2019 is currently showing an unrealized profit for the whole portfolio of ca. 4.75% (25% of funds committed at the bottom x 19%). Adding to a winner is much easier than just starting a 100% new position at +19% from the bottom. This is why I must write soon some new posts concerning capitulation. The more I trade, the more I realize that capitulation is important. More important than I thought, I confess. Hence, we must acquaint ourselves fully with “capitulation”. My next post will deal with this subject.

GOLD AND SILVER

The primary and secondary trend is bullish since 12/24/2018 as explained here. No changes. The most recent pullback did not fulfill the time requirement for a secondary reaction. Hence, no secondary reaction.

GOLD AND SILVER MINERS ETFs

The primary and secondary trend is bullish since 12/18/2018 as explained here. No changes. 

The most recent pullback did not fulfill the time requirement for a secondary reaction. Hence, no secondary reaction.

Sincerely,
The Dow Theorist



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