Wednesday, September 2, 2020

Dow Theory Update for September 2nd: US bonds are in a secondary reaction when one takes a somewhat shorter time frame.


No secondary reaction when one is bound by the 1/3 confirmed retracement dogma


This post is being penned on Saturday, August 29th, but will likely be posted on Wednesday 9/2/2020. I am looking at the charts today, and I see now changes in my analysis of trends.


Today I’ll focus on US bonds. This post may not be an easy read, as it’s packed with lots of analysis. However, hard work is the price we have to pay for performance (40% for TLT since the Buy of 11/19/2018) and, more importantly, drawdown reduction. Nonetheless, it is good to keep sober and bear in mind that a dry spell of bad trades is always around the corner. The important thing is to stay disciplined and not throw in the towel when a couple of sour trades eventually hit.  



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.


A) Market situation if one is to appraise secondary reactions not bound by the 3 weeks and 1/3 retracement 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. The decline just took 7 trading days, and, thus, one could argue that the time requirement for a secondary reaction against primary bull market had not been met. However, given the magnitude of the shake-up, retracement 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 became the lows of a secondary reaction of just seven trading days.



From the secondary reaction lows of 3/18/2020, both ETFs bettered their last recorded primary bull market highs of 3/9/2020. IEF did so on 04/01/2020, whereas TLT did so on 8/4/2020, thereby reconfirming the primary bull market, as was explained in-depth here.


By the way, TLT’s confirmation of the higher highs made by IEF took quite a long time, namely more than 4 months. Belated confirmations tend to be a warning sign about the underlying health of the trend.


The very day of TLT’s confirmation (8/4/2020) was the day of the market top. From that date, both TLT and IEF have declined. There was a first pullback which ended on 08/14/2020 (TLT, 8 trading days) and 08/13/2020 (IEF, 7 trading days). Percentage-wise this pullback amounted to -4.52% for TLT and -1.37% for IEF.


Retracements are measured from the last recorded secondary reaction lows (3/18/2020). As you can see in the spreadsheet below, the pullback finishing on 8/14 and 8/13/2020 was well under 30% for both ETFs.


The spreadsheet below summarizes all the data:


 Given that we have not seen significant volatility (the pullback did not even reach 5% for TLT), that the retracement has not even managed to reach 1/3 (even on an unconfirmed basis) and that it has just been 7 and 8 days, I feel I cannot consider such a pullback a secondary reaction, even if one is to be flexible and do away with the three weeks and 1/3 retracement dogma. I can settle with a pullback spanning just 7 days, but, as a trade-off, I want to see more significant volatility, which is obviously absent.

This is why I display the pullback finishing on 8/14 and 8/13/2020 in grey color. Readers of this blog know that I use “blue” to display a bullish secondary reaction and “orange” to display a bearish one. Grey is the color I use to show neutrality. Here you have an updated chart, which also shows the secondary reaction when one takes some more days into account (orange rectangles on the right side of the charts):


Furthermore, the mini-rally that started off the 8/14 and 8/13/2020 closing lows and ended on 8/21/2020 did not reach the minimum volatility-adjusted threshold, as you can see on the table below:

Thus, any way you cut it, the pullback finishing on 8/14 (TLT) and 8/13/2020 (IEF) cannot be qualified as a secondary reaction, even if one is kind of flexible.

On the other hand, I feel that the lows made on 8/28 (TLT) and 8/27 (IEF) do qualify as a secondary reaction when one is not bound by the 1/3 confirmed retracement dogma. Let’s look at the entrails of this larger pullback.

First off, the decline lasted 18 trading days for TLT and 17 for IEF. No doubt as to the fulfillment of the time requirement.

 As to the extent requirement, TLT has retraced 38.39% of the advance that started off the secondary reaction lows of 3/18/2020. This is a decent retracement. It is true that is has been unconfirmed as IEF merely retraced 25.90%. I have written, though, that Rhea in his book “The Story of the Averages” boldly wrote that the retracement requirement need not be confirmed. He noted that confirmation could come in direction (which we did, as both ETFs declined). Rhea identified many secondary reactions that did not comply with the 1/3 retracement requirement on a confirmed basis. 

Furthermore, percentage-wise, TLT declined -6.09% (while its minimum volatility-adjusted movement stands around 2.17-2.44%, depending on the time one takes for the calculation) and IEF -1.53 (with a minimum volatility-adjusted movement around 0.70 – 0.95%). More about the minimum volatility-adjusted movement, here.

So given the sheer magnitude of the decline, the existence of a retracement clearly exceeding 1/3 in TLT and a sufficient amount of time (18 and 17 trading days), I consider the decline starting on 8/4/2020 and (for the time being) ending on 8/28 (TLT) and 8/29/2020 (IEF) as a secondary (bearish) reaction against the primary bull market.

Here you have a spreadsheet containing all the data. 


A position taken in TLT on 11/19/2018 (date of the primary bull market signal) is currently showing an unrealized profit  of 40.07% (at the close of 8/29/2020). An extra reason not to be too sluggish when it comes to defining secondary reactions that may eventually lead to a sell signal. 


Finally, volume on 8/27/2020, the day where the 8/14 (TLT) minor lows were broken down was notably higher than that seen at the minor lows (19.86 million on 8/27, 8.4 million on 8/28 for TLT versus ca. 6.4 million on 8/14. For TLT volume was roughly similar both on 8/13 and 8/27). While volume is notably less dependable than price action, the increase in volume at the breakdown point seems to further validate the existence of the secondary reaction.

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement 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 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. An in-depth explanation here.


The last recorded primary bull market highs were made on 8/4/2020. From that date, TLT declined until 8/28/2020 for 18 trading days, whereas IEF declined until 08/27/2020 for 17 trading days. Hence, the time requirement for a secondary reaction has been met.


As to the extent requirement, we have had a very modest retracement of the previous bull market swing of just 28.51% for TLT and 14.6% for IEF. As a reminder, retracements are measured by taking the last secondary reaction lows until the last primary bull market highs, and then considering the ongoing pullback. Given that as per this “strict” interpretation of the Dow Theory, we didn’t have a secondary reaction on 3/18/2020, we have to go back to 11/8/2019 and 12/23/2019, which were the closing lows of the last completed secondary reaction. Of course, this makes quite a considerable bull swing, and the current decline has barely made a dent in it.


So, if we are to take a strict reading of the Dow Theory and demand 1/3 retracement, we are still far from it, and, hence, the extent requirement has not been met, and, thus, no secondary reaction has been signaled yet. 


The table below shows all the calculations:


Here you have an updated chart that shows all the price action since the lows of the last completed secondary reaction by the end of 2019 until today. The grey rectangles on the right side of the charts display the ongoing pullback.



One Dow Theorist


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