Friday, April 5, 2019

Dow theory Update for April 5st: Back to divergent interpretations of the Dow Theory

Trends unchanged for US stocks, gold, silver and their miners

Cervantes’ master piece “Don Quixote of la Mancha” starts as follows:

“In a village of La Mancha, the name of which I have no desire to call to mind, there lived not long since one of those gentlemen that kept a lance in the lance-rack….”

Well, there is also one Dow Theorist, “the name of which I have no desire to call to mind” who persistently seems to misapply the Dow Theory. No need to give names.

That Dow Theorist has recently penned that a bull market will not be signaled until the Industrials and Transports better the last recorded all-time highs. He also notes that the Transports are well below such all-time highs.  Well, this interpretation of the Dow Theory is plainly wrong. As an aside, both Schannep’s and my interpretation of the Dow Theory signaled a primary bull market signal on April 1st. 2019, as was explained here.

Here you have an updated chart (concerning the “Rhea/classical” Dow Theory). The red horizontal lines display the secondary reaction highs which were jointly broken up on April 1st, 2019. On the other hand, the green horizontal lines display the alleged level to be penetrated so that a primary bull market is signaled as per the reading of that Dow Theorist. Such green lines display the last recorded all-time highs which hitherto have not been broken up by neither the Industrials (top chart) nor the Transports (bottom chart).

Red horizontal lines display the "normal" more timely bull market signal. The thick green lines display the last primary bull market highs

No wonder the Dow Theory gets a bad rap if people claiming to apply the Dow Theory apply it badly. Waiting for all-time highs to be exceeded is incorrect application of the Dow Theory and ignores that according to Rhea one can glance three alternative primary bull market signals.

1)     The first one (and normally occurring first) the typical secondary reaction against the primary bear market, pullback, and confirmed penetration of the secondary reaction closing highs. This is the signal we got last April 1st.

2)     Absent a pullback following the secondary reaction, breaking up the last completed (the previous one) secondary reaction is an alternative entry level.

3)     Absent “1” and “2” the last recorded primary bull market highs serve as the stopgap, last resort, primary bull market signal. 

Ignoring “1” and “2” signals is tantamount to belatedly signaling a primary bull market when the risk/reward of the trade concerned is no longer so good. There is less upside (reward) and much more downside (risk). As an aside, this is why Schannep’s Dow Theory by being more reactive has a better risk profile than the “Rhea/classical” Dow Theory.

Here you have a “pedestrian” chart of my own which displays the three alternative entries. Of course, waiting for the last one (highs of the last primary bull market) in order to consider a change of trend is plainly wrong. It would only be right if no signals “1” and “2” occur first. 

Three alternative primary bull market signals

By the way, some weeks ago, I criticized some Dow Theorists for their failure to timely detect the change from bull market to bear market. That post served to clarify the alternative signals. Here you have the relevant post, which also serves to help understand the present post (both are the two sides of the same coin. The past post concerning the calling of a primary bear market, and the present one concerning the calling of a primary bull market).

In such a post, I mentioned that by being late signaling the primary bear market 4.5% was lost due to overstaying. By the same token, waiting until the last primary bull market highs are broken up may imply an additional loss (gains which are not made) of ca. 5-10%. Thus, if you add up the points lost by exiting too late and the gain lost by having a belated entry, you can see the importance of proper timing.

Hence, readers of this blog beware: Not all signals given in the name of the “Dow Theory” are to be believed as being the best “Dow Theory”. Discern.

The Dow Theorist.

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