Monday, August 24, 2020

Dow Theory Update for August 24: Primary bull market in US bonds reconfirmed

 

Primary and secondary trend for precious metals and their ETF miners remain bullish

 

General remarks

 

There is bullishness everywhere. US stocks, US bonds, and precious metals are all undergoing solid primary bull markets. Of course, trends can reverse. However, as of this writing, there are no secondary reactions in sight. It feels like a melt-up where everything is bought up (maybe caused by the decline of the US dollar?). While I don’t usually publicly write about the Euro and the Swiss Franc (they make a good pair so that we can analyze them under the Dow Theory), they seem to be in a nascent primary bull market. 

 

When so much bullishness prevails, one should be extra attentive and not get too carried away by emotions (unrealized profits). Now everyone is bullish on gold and silver; even perma stocks bears are throwing in the towel and becoming bulls, as you can read in this Zero Hedge article, which should be a cause for concern (too much company on the long side). 

 


By the way, the fact that such staunch bears are admitting defeat should give us pause. Opinions, even well-articulated ones from brilliant minds, can cost us dearly. This is why I remain at heart, a trend follower. We are not omniscient, and fundamental opinions may inadvertently lack one vital element. The lack of such a feature may result in the complete analysis being wrong, no matter how brilliant it looks. 

 

In today’s post, I’ll focus on US stocks and US interest rates. However, please keep your eyes open on precious metals and their miners. As I explained here and here, we could be near the onset of a secondary reaction. Those trying to emulate Rhea (which implies lots of toil, asno pain no gain”) and thus try to unload shortly before or at the onset of a secondary reaction, should closely monitor the breaking down of 08/11 and 08/12 closing lows on increasing volume. For those riding primary trends, barring an overnight gap, the primary trend is well entrenched. 

 

 

Schannep’s Dow Theory (more properly: The Dow Theory for the 21st Century)

 

 

At 08/19/2020, the primary trend was bullish since April 6th, 2020, as was explained here.

 

The April 6th, 2020 Buy signal (caused by a Bull market definition) was not an easy one to act upon, as it was given at ca. 19% (for the S&P 500) off the bear market bottom. Fear that the market was already overextended and fear of a significant loss should the market decline revisiting the 03/23/2020 bear market lows resulted in some investors expressing concern. An in-depth study about the viability of the Buy signal of April 6th, 2020, is available in our June 1st, 2020 Letter to Subscribers of thedowtheory.com. Since many followers of this blog have become Subscribers, please read carefully the June 2020 Letter. For those still sitting on the sidelines, I encourage you to become Subscribers.

 

Subsequent price action is, once again, proving that those fears were unwarranted. The current primary bull market signal is very likely to end up as a winning trade (barring a huge overnight gap down). As with all bull markets, this one has to climb its own wall of fear.

 

The secondary trend was declared bearish on 06/26/2020, as was explained here. 

 

On 7/20/2020, the S&P 500 bettered its 6/8/2020 primary bull market highs unconfirmed. On 8/4/2020 and 8/10/2020, the Transports and the Industrials confirmed, so the secondary reaction was canceled, and the primary bull market reconfirmed. 

 

 “Rhea’s /classical" Dow Theory

 

A) Market situation if one is to appraise secondary reactions not bound by the 3 weeks dogma.

 

The primary trend is bullish since 4/29/2020, as explained here. This primary bull market signal was determined by just demanding 13 and 18 trading days to appraise the secondary reaction that led to the primary bull market signal. 

  

 I recently wrote a “saga” (herehere and here) where I made clear that neither the 15 days time requirement nor the 1/3 extent requirement is carved in stone. While most secondary reactions will last more than 15 days and retrace 1/3 of the previous swing, one should remain flexible, even under the “Rhea/classical” Dow Theory. 

 

On 8/4/2020 and 8/10/2020, the Transports and the Industrials bettered their 6/8/2020 primary bull market highs and, thus, the primary bull market was confirmed. Please mind that no secondary reaction was canceled by the higher highs, as the decline did reach the necessary time and (more importantly) extent proportions to qualify as a secondary reaction (more details in this post)

 

 

Here you have an updated chart:

 

 

 B) Market situation if one sticks to the traditional interpretation demanding more than three weeks of movement in order to declare a secondary reaction.

 

For those strictly demanding more than 15 confirmed days of declining prices, the primary bull market was signaled on 5/26/2020. More details about this alternative signal are to be found in our June 1st, 2020 Letter to Subscribers.

 

Following the 6/8/2020 highs, both the Industrials and Transports declined for several days. However, neither index exceeded 15 trading days of decline, so the time requirement for a secondary reaction was not met. So no secondary reaction was signaled.

 

On 8/4/2020 and 8/10/2020, the Transports and the Industrials bettered their 6/8/2020 primary bull market highs and, thus, the primary bull market was confirmed.

 

Here you have an updated chart:

 

 

US INTEREST RATES

General Remark:

TLT is the iShares 20 years + Treasury bond ETF. More about it here

IEF is the iShares 7-10 years Treasury bond ETF. More about it here.

Thus, TLT tracks longer term US bonds whereas TLT tracks middle term US bonds. A bull market in bonds entails lower interest rates. As you will read below the current situation for both the primary and secondary trend is bullish which implies that the trend for interest rates is down. In spite of some who say that bonds must go down because inflation is coming, the primary bull market has been reconfirmed (which suggests lower interest rates ahead)....We follow the trend, and try not to argue with the markets.

 A) Market situation if one is to appraise secondary reactions not bound by the 3 weeks dogma.

 

If one appraised the secondary reaction that led to the setup that resulted in the primary bull market signal, the primary bull market was signaled on 11/19/2018. The signal of 11/19/2018 was obtained by being satisfied with just 14 trading days for TLT and 15 days for IEF.

 

 

From the 03/09/2020 closing highs, both ETFs declined until a bottom was made on 3/18/2020. Hence, there has been just seven days of decline, and, thus, the time requirement for a secondary reaction against the strong bullish trend has not been met. However, given the magnitude of the shake-upretracement of the last bull market swing, and the total percentage of the declines, I’d be inclined to shorten the time requirement so that the 03/18/2020 closing lows become the lows of a secondary reaction of just seven trading days.

 

On 04/01/2020, IEF bettered its last primary bull market closing highs of 03/09/2020 unconfirmed by TLT. On 4/21/2020, TLT equaled its previous recorded primary bull market high of 03/09/2020 but could not better it. One tenet of the Dow Theory is that we need penetration, just one decimal or cent suffices (Rhea debunked the notion that penetration had to be “decisive”). On 08/04/2020 TLT finally deigned to confirm and broke up its 3/9/2020 primary bull market highs, and, hence, the primary bull market was reconfirmed, and the secondary reaction was put to an end. So now both the primary and secondary trend is bullish

 

 

 

Here you have an updated chart. The orange rectangles display the secondary reaction of just seven days associated with significant declines both in terms of retracement of the preceding bull market and the subsequent breaking up of the primary bull market highs. 

 

 

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks of movement in order to declare a secondary reaction.

 

The signal of 12/18/2018 was obtained by being strict and demanding on a confirmed basis at least 15 trading days on both ETFs.

 

Since the pullback from 03/09/2020 to 03/18/2020 spanned just seven trading days, and despite its vast magnitude, we could not declare the existence of a secondary reaction if bound by the three weeks' time requirement dogma. Subsequent declines did not manage to close below the 03/18/2020 closing lows and hence no secondary reaction was signaled.

 

On 04/01/2020, IEF bettered its last primary bull market closing highs of 03/09/2020 unconfirmed by TLT. On 08/04/2020, TLT finally deigned to confirm and broke up its 3/9/2020 primary bull market highs, and, hence, the primary bull market was reconfirmed.

 

Here you have an updated chart:

 

 

Sincerely,

One Dow Theorist

 

Monday, August 10, 2020

Dow Theory Update for August 10th: Divergence and the Dow Theory

 

Case in point: Precious metals right now

 Caveat: I'm publishing this post before the close, so things might change.

The Dow Theory has it that higher highs (lows) unconfirmed have no validity in signalling changes of trends. We also now that the principle of confirmation has more validity the longer the time frame. Thus, a change of the primary trend signaled by the breaking up/down of the secondary reaction highs/lows has more validity than the breaking out of a minor pivot point.

 

While divergence may result in lack of confirmation, it is not equal to lack of confirmation. We can have two indexes making higher highs but one of them going up with less strength and hence failing to better and old high. However, in spite of the lack of confirmation, both indexes had an upward movement.

 

Divergence entails one index going up whereas the other is going down. So what’s the use of divergence under the Dow Theory? Divergence acts as a kind of yellow traffic light. There are three uses of divergence:

 

1.      Divergence serves us to occasionally disregard primary bull/bear market signals. Schannep in real life (Letters to Subscribers and his personal audited portfolio) has done so several times, all of them with success. A future post will analyze how Schannep uses divergence as a warning sign. Divergence as a tool to make an educated guess as to when to disregard a Buy/Sell signal has been proven helpful to avoid being whipsawed in the past, and will likely continue in the future.

 

2.       Divergence is one of the main tools that Rhea used in order to time the start of a secondary reaction. As I wrote here, there are several Dow Theory “flavors”. One of these flavors attempt to exit (or lighten up) positions at the start of a secondary reaction with the hope of re-buying at a lower level when the secondary reaction seems to have run its course and the primary trend reasserts itself. Rhea also used, among other factors, volume in order to time the start of a secondary reaction. It is beyond the scope of this post to explain how to time the start (and end) of a secondary reaction. Those interesting in mastering the art of timing secondary reactions should read in addition to the classic “The Dow Theory”, Rhea’s “Dow Theory Comment” and “The Story of the Averages”. Make sure that you read all these books and least three times.

 

As I explained here, Rhea, after spotting divergence, normally waited for a small confirmed pullback of a few days. By “few” I mean as little as one or two days followed by a small rally which fails to better the last recorded highs on a confirmed basis. Thereafter, both indexes should breakdown the small pullback lows. Rhea paid lots of attention to the volume of the decline that led to the day of the breakdown. He also looked at the volume on the day of the breakdown. Increasing volume tends to imply that lower prices are ahead (that is a secondary reaction). On such a breakdown, and provided other factors where met, Rhea used to partially or totally sell his positions. One thing is clear, while Rhea was a trend follower in the sense that he never fought against the primary trend as determined by the Dow Theory, he did not advice to buy or sell at the very primary bull and bear market signals. He tended to unload at the star of a secondary reaction and replenish his line once there were signs that the secondary reaction had run its course. Please mind that Rhea’s Dow Theory is not exactly the same as Schannep’s Dow Theory (more accurately, “The Dow Theory for the 21st Century”) and hence, I don’t advocate timing secondary reactions when under the realm of Schannep’s Dow Theory. One day, I will write in depth why. We are dealing with two different beasts.

 3.      Paradoxically, divergence also serves to further validate the primary trend once divergence stops and the two (or three under Schannep’s Dow Theory) indexes are back in sync. Thus, after some days of divergence, a breakup in the direction of the primary bullish trend, tends to be followed by more strength.

 

So armed with this knowledge, let’s have a look at gold and silver.

 

The primary trend, it is bullish irrespective of the way you appraise the primary trend since 2/19/2020. An in-depth explanation of the current trend here.

 

As you can see in the chart below starting 07/23/2020 we had 3 days of divergence (highlighted by red arrows). SLV (silver ETF) closed down whereas GLD (gold ETF) closed up. Following this period of indecision, there was what seems a blow off move (for SLV on higher than average volume for GLD on normal to higher volume) until 08/06/2020 when higher highs were made on a confirmed basis. Yesterday, Friday 08/07/2020 both precious metals declined on slightly higher volume.

 

So those intend on trading secondary reactions may well monitor the action that will follow in the next few days. It is up to each trader to decide what to do. As a reminder unrealized profits are mounting as you can see in the table below:

 

 

It is worth mentioning that SIL and GDX (the silver and gold miners ETFs) have declined for two days, hence providing another source of divergence.

 

As to the trend of SIL and GDX, it is bullish any way we measure, as was explained in depth here.

 Given the extent of unrealized profits for the ongoing trade (which was explained here), those aiming at modelling Rhea might well look for the onset of a secondary reaction in order to lighten up positions. Below the table showing the amount of unrealized profits.


 

Final thought: The trades taken in pursuance of the Dow Theory closely resemble the pattern of trades taken with most trend following systems (albeit there is a larger percentage of winners). Most of the winning trades tend to be of modest proportions. Losers are well contained. However, every now and then, there is a huge winning trade. In our trading life years pass and performance albeit normally positive remains muted. The patience of many investors gets tested. When many throw in the towel, then the big trade sets in. In trading, and especially when longer term trading, we don’t have the privilege of generating many trades so that the big one may take quite a long time to materialize. This is why investors should strive for strengthening their patience, and, just in case patience remains weak, generating many trades (several time-frames, several asset classes) so that the time between big winning trades is shortened.

 

Sincerely,

One Dow Theorist