Do Dow Theorists need to establish profit objectives?
Rhea wrote
that the Dow Theory could not forecast the extent of a rally or decline. In
other words, the Dow Theory determines likely direction, and we take what the
market offers us. However, Schannep long time ago incorporated into his arsenal a tool
that allows him to establish price objectives.
That tool is
named “the Rule of Seven,” and while not created by Schannep, as far as
I am aware of, it has been Schannep the investor who has put it most to use,
and with documented success.
I know
“purists” will be screaming “heresy,” as one of the tenets of the Dow Theory is
that neither the time nor the extent of a primary movement can be determined in
advance. However, I’d like to point out the following:
1) Rhea availed himself of loose price objectives
based on market action. Yes. In
actual trading, Rhea was often trading around secondary reactions. That is
buying when he felt that a secondary reaction had run its course (which is a
price objective based on retracements), and, more importantly, selling when
he thought that there was an impending secondary reaction. A future post will
further explain all this, and why we should not attempt to emulate Rhea’s
trading when using Schannep’s Dow Theory. The takeaway for this post is
that Rhea, in many instances, “sensed” that the bull swing was overdue for a
correction (i.e., because the swing has lasted or advanced more than the
average swing) and ran for the exits before an actual Dow Theory sell signal
was given.
“It is hoped that no readers of these letters got
caught in the crash. It so, it is not the fault of this writer or of Dow’s
Theory. In Mailing 29, July 19 (Ind. 103.58, Rls. 54.01) we stated: “The nearby
trend is downward”
“The Ind. made a new high – the Rls. Refused to confirm- then both averages broke
down through the preceding minor lows. No believer of Dow’s theory, as
interpreted in these letters, should have been caught in the recent panic
decline. The warning and the picture were there for all to read”.
Note: Ind. means Industrials, and Rls. means “Rails, that
is Transports”.
The funny thing, though, is that Rhea recommended
cashing out just one day after the
market top of the Industrials (07/18/1933 top). If one reads Rhea’s
letters in the weeks leading up to the top, Rhea clearly thought that the
market was more than overextended. Hence, at the very first sign of weakness (a
minor non-confirmation and the breakdown of a very minor low) Rhea decided to sell out.
2) Rhea
wrote that higher confirmed highs carry less importance the older the bull
swing gets. Eventually,
there will be a turning of the trend. Or as legendary trend follower, Ed Seykota
said, “the trend is your friend except at
the end when it bends”. So while remaining trend followers, there are
instances when cashing out may be in order. For this very reason, Schannep uses
Capitulation which is just betting for a reversal to the mean. We want to make
money in the markets, not to be zealots of one sect called trend following. We
know, though, that 90% of the time, we will be in a pure trend following mode
simply because it works. However, there will be some occasions when we are
buying extreme weakness (capitulation) and selling strength (Rule of Seven,
profit objective). The art, which Schannep has fine-tuned to almost perfection,
is to know which exceptional weakness should be bought and which strength
should be sold.
3) Even for those reluctant to using price objectives and
willing to wait until finally stopped out, sensible
price objectives serve to know when to tight stops. I give you an example
from my actual practice: When dealing with non-US stock markets, I am forced to
use “Rhea’s Dow Theory”, as I don’t have the privilege of having three indices. Readers know that under the classical Dow Theory,
unlike Schannep’s, there are no hard and fast rules for determining a secondary
reaction, so there is ample room for interpretation, and this is why I insist
that outside of the realm of Schannep’s Dow Theory, one is well advised to
accept alternative appraisals of secondary reactions to split the risk. This is
why Rhea wrote that “no two students
would agree on any rule for selecting” secondary reactions. In other words,
depending on each one’s interpretation secondary reactions may vary in length
and extent, which translates into tighter or looser stops. And here comes the beauty of having price objectives: When I know that
prices are in the profit objective zone, I demand fewer days and, normally,
less extent to declare the existence of a secondary reaction. Additionally,
I pay more attention to non-confirmations at higher highs, and, I even take a
look at volume. The result is a “tighter”
stop based on a secondary reaction that has been appraised with less time
and extent than usual. My next post will surprise you as Rhea went as low as
just 7 days (and sometimes he even did away with confirmation) to declare a
secondary reaction. However, Rhea was no fool, and he knew when it was time to
be satisfied with just 7 days and when it was time to require more time.
For the three reasons given above, I feel the use of good price objectives
(as usual “good” is the word, as not all rules to calculate profit objectives
do work in actual trading) is a valuable
addition to one’s trading arsenal.
It is worth remembering that Schannep nailed it down
in his February 1st, 2020 letter to Subscribers. In real-time, based on the price objective established by the
application of the “Rule of 7”, Schannep alerted his Subscribers and wrote “I am doing some lightening up in my other
accounts.” Please mind: That sentence was written on February 1st,
2020 just days before the market top
If you are really serious about making (or at least
not losing) money in the stock market, do yourself a favor: Read at least three
times the followed linked Letter (February 1st, 2020) to Subscribers. It’s free.
All in all, the Rule of Seven is a valuable tool to
determine price objectives that may be successfully applied in our actual
trading decisions. This post does not deal with the entrails of the “Rule of
Seven” which are explained with great detail and real trading examples on the
Subscribers area of Schannep’s website “thedowtheory.com”. You can get access to the Rule of Seven report by becoming a free Subscriber.
Continue reading.
As I announced here, I joined Schannep’s “thedowtheory.com”
as a contributing editor.
As an expression of gratitude to the
followers of this blog, and as an invitation to follow me on my new home
“thedowtheory.com”, I will be offering for the next few weeks a free two months subscription. For a
FREE Trial, send an email with your name
SUBJECT: Free Trial
That's
it!
As a reminder Subscribers to “thedowtheory.com” Letter
get real-time information when action is required, something one cannot get in
this blog. Furthermore, “thedowtheory.com” really helped Subscribers navigate
through the recent turbulent waters as:
2) Our definition of a Bear market beat all others to
the punch in March
3) Capitulation (the time to start buying) was
signaled throughout two weeks in March
4)
Our definition of a Bull market was met earlier last month confirming
this up market
5) We have once again determined the upcoming Rule of
Seven target for the new bullish swing.
While my blog is instructive and remains a valuable
tool to dig deep into vital aspects of the Dow Theory, those truly intent on getting
actionable and real-time advice with a proven and disclosed record should use “thedowtheory.com”
as a companion to this blog.
Sincerely,
One Dow Theorist
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