Shortening of the time requirement for secondary reactions
As a reminder, I have been writing about capitulation in the following posts.
As I explained in the past, “capitulation” is a mean reversing tool. When markets get severely oversold, we derogate from trend following, and bet for a trend reversal. The track record of the “capitulation” indicator is outstanding. It works.
However, “capitulation” is not just a tool to signal the opening of a partial long commitment, it also serves to shorten the time requirement needed to declare the existence of a secondary reaction. Of course, if capitulation serves to shorten the time requirement for a secondary reaction indirectly it serves to set up stocks for a primary bull market signal. As we know, for a primary bull market signal to exist, we need first to get a secondary reaction (and thereafter, a pullback and subsequent breakout). Thus, capitulation not only implies the opening of a partial long position at the very moment it is signaled, but also “eases” the requirements for a primary bull market signal by shortening the time requirement.
Schannep in his newsletter to subscribers of November 1st, 2008, shortened the time requirement for a secondary reaction to just 1 week following capitulation. In other words, following the last lows after or at capitulation, just ONE week of a rally exceeding 3% (confirmed by at least two indices) will suffice to declare a secondary reaction.
It is good to recall Schannep’s requirements for a “normal” secondary reaction in order to derive the specific rules for the “shortened” secondary reaction.
Here are the rules for a “normal” secondary reaction:
A secondary reaction which interrupts the primary trend must last a minimum 10 calendar days on 2 of the 3 indices with at least 8 trading days as the average of all three indices (Dow Jones Industrials, Transports, and the S&P500)
Hence, if we halve the time requirement. We could rewrite the rules for a shortened secondary reaction as follows:
A secondary reaction which interrupts the primary trend must last a minimum 5 calendar days on 2 of the 3 indices with at least 4 trading days as the average of all three indices (Dow Jones Industrials, Transports, and the S&P500).
This is why, after the capitulation event of December 24th, 2018, I was looking for a secondary reaction as soon as we had had a rally lasting four trading days, as was explained here
All in all, capitulation not only prompt us to act by opening a partial long commitment, but also serves us to shorten the time requirement for a secondary reaction which results in full primary bull market signals being signaled earlier.
The Dow Theorist