Tuesday, December 27, 2022

Dow Theory Update for December 27: Setup for a primary bull market for GDX & SIL completed on 12/19/22

 This setup pertains to the long-term version of the Dow Theory



1. As a reminder, gold and silver have been in a primary bull market since, as I explained HERE

2. The shorter-term appraisal of the trend for SIL and GDX has been bullish since 11/10/22, as I explained HERE.

3. The longer-term appraisal of the trend for SIL and GDX remains bearish, but the setup for a potential primary bull market signal was completed on 12/19/22. So, to turn conclusively bullish, I'd like to see this trend becoming bullish too. We are at a make-or-break moment for the precious metals miners.

4. A break-up of the 12/1/22 (GDX) and 12/2/22 (SIL) closing highs would be a very bullish development.


A) Market situation if one appraises secondary reactions not bound by the three weeks dogma.

I explained HERE that the primary trend was signaled as bullish on 11/10/22.

The secondary trend changed to bearish (secondary reaction against the bull market). Following the 12/1/22 (GDX) and 12/2/22 (SIL) closing highs, both ETFs dropped until 12/19/22 for 12 and 11 trading days, respectively, which satisfies the time requirement (at least 10 confirmed trading days). Percentage-wise the pullback also met the extent requirement, as the decline amply exceeded the Volatility-Adjusted Minimum Movement (VAMM). More about the VAMM here.

The Table below displays the most recent price action that led to the development of the secondary reaction:

 Following the 12/19/22 closing highs, a rally ensued, which, until now, does not meet the VAMM, and hence no setup for a potential primary bear market signal has yet to be completed.

The charts below highlight the rally that started off 9/26/22 closing lows (blue rectangles), the new primary bull market signal (blue arrow), and the most recent pullback (secondary reaction, brown rectangles). The grey rectangles on the right side display the most recent rally, which lacks the extent to set up GDX and SIL for a primary bear market signal.


B) Market situation if one sticks to the traditional interpretation demanding at least three weeks of movement to declare a secondary reaction.

The primary trend was signaled as bearish on 8/9/2021, as was explained here.

Starting off the 9/26/22 closing lows, a rally ensued that qualifies as a secondary (bullish) reaction against the primary bear market, as I explained HERE.

Following the 12/1/22 (GDX) and 12/2/22 (SIL) closing highs, both ETFs dropped until 12/19/22 for 12 and 11 trading days, respectively. Such a pullback lasting >=2 trading days and exceeding the VAMM sets up GDX and SIL for a potential bull market signal.

The table below displays the price action following the 9/26/22 primary bear market lows:


The charts below highlight the rally that started off 9/26/22 closing lows (blue rectangles). Such a rally qualifies as a secondary reaction against the primary bear market. The brown rectangles show the most recent pullback that set up GDX and SIL for a potential primary bull market signal. The grey rectangles highlight pullbacks that, for lack of extent, did not complete the setup for a bear market signal. The blue horizontal lines display the price levels to be broken up to trigger a new primary bull market. 

Sincerely ,

Manuel Blay

Editor of thedowtheory.com

Friday, December 23, 2022

Understanding the Dow Theory: Money.Net interviews Manuel Blay


I thank Steven Orr of Money.net for inviting me to his show on 12/14/22. We discussed how and why the Dow Theory outperforms Buy & Hold and took a look at Capitulation, our bottom-picking indicator. If you want to understand what makes the Dow Theory one of the best trend-following systems, you may watch the interview in the link below:





Manuel Blay

Editor of thedowtheory.com

Monday, December 19, 2022

Realistic expectations from Trend Following (Dow Theory included)

 A much needed reality check


I have shown many times in this blog that the Dow Theory works unambiguously not only with stock indexes but also with other markets (i.e., HERE and HERE). What do I mean by “work”? I mean four things:

1. That we achieve outperformance v. Buy & Hold (BAH).

2. That we achieve drawdown reduction v. BAH

3. We can apply it to many markets (not an “oddity” with stock indexes).

4. That it works on the short side even when facing headwinds caused by secular bull markets (example HERE and HERE)

In this post, I explained why the Dow Theory not only “works” but beats most, if not all, known trend-following systems.

So, everything seems rosy. Let’s use the Dow Theory, which will be the stress-free and sure way to get rich. Well, it is true that if one is patient and long-term oriented, one can get rich. However, I know firsthand that most people become trend followers with distorted expectations. When confronted with a couple of losing or just sub-optimal trades, they become discouraged and throw in the towel in disgust. Typically, they become trend followers after a beautiful run-up seen from the sidelines (greed) and quit when the recovery is at hand (fear). Lack of consistency and discipline is their downfall.

This post aims to give a reality check. Below I show the four issues every investor should cope with when using the DT (or any trend-following system):

1. Most trades are small winners & small losers. Given that, by definition, you seldom buy at the bottom (except Capitulation for U.S. stock indexes, as explained HERE and HERE, and links contained therein) and never sell at the top, you will never catch the whole swing.

2. When you sell, your next re-Buy will, in most instances, be at a higher level, discouraging many investors.

3. Depending on the trending characteristics of each market, you’ll have between 60% and 30% of losing trades. The U.S. bond market, which performed beautifully with the DT, only had 50% of winning trades. Thus, half the time, we had to put up with losing trades.

4. While long-term, the DT outperforms, given the lack of trades, the spells of underperformance may last significantly. From 1953 to 2021 (68 years), there were 21 years where the Dow Theory for the 21st Century (DT21C, which is an improved version of the DT) underperformed BAH. Therefore, ca. 30% of the time, the DT underperformed annually. If we take rolling 5-year periods, things get better: 17.5% of the time, the DT underperformed, which means that 82.5% of the years, the DT outperformed BAH. Hence, patience is vital.

Of course, the four above-mentioned “drawbacks” affect other trend-following systems even more than the DT. The more accurate and profitable the system, the less pronounced the “disadvantages” will be.

So how does the DT achieve outperformance? Every now and then, a significant drop decimates Buy & Hold. By getting out early, the Dow Theory may lose, let’s say, 10% instead of 40% for BAH. To recover 10%, we need 11.11%. However, to make up for a 40% loss, we need 67%. Therefore, the significant drawdowns that sooner or later afflict BAH are the source of the Dow Theory outperformance. According to my experience, even a 15% drawdown may result in outperformance for the Dow Theory. However, it can be challenging for many investors to wait for years for the big drawdown. Years pass by, and the Dow Theory fails to outperform while performing (that is, being profitable). In this post, I proved that the worst years for BAH are usually the best years for the Dow Theory. Intelligent investors will see that the weak correlation of returns between the Dow Theory v. BAH makes it an excellent diversifier. Furthermore, since the Dow Theory works across many markets, the investor should aim to build a diversified portfolio across many asset classes (at least including bonds), and those more sophisticated should even have some allocation to the short side. By going long and short and diversifying across markets, one can significantly reduce the periods of underperformance v. BAH.

The trader must also learn to navigate through uncertainty. When opening or closing a given trade, we don't know whether it will be successful or whether the next re-Buy will be at a higher price (the abhorred "whipsaw"). We go with the flow and take what the market gives us. We know that some trades will result in underperformance (but not necessarily "lack of" performance), and we stay the course. However, many traders get incredibly annoyed when the next re-Buy is at a higher price level prompting them to think that they should become "Buy and Holders". In real-time, nobody knows what will happen after a Sell. We deal with uncertainty. Re-buying at a slightly higher price level is the price we pay for the "insurance" against the big drawdown that sometimes happens. The profile of trades taken under trend-following (and the DT) is that most trades are a "re-Buy" at a higher price level. However, in some trades, the drop following a Sell is breathtaking and more than compensates for the re-Buys at a slightly higher price. Patience and faith in trend following are required.

One trade is statistically irrelevant. However, when several trades pile up, a pattern of outperformance and drawdown reduction v. Buy and Hold emerges. Of course, to reap the coveted fruit of outperformance & drawdown reduction, one must stay the course and not throw in the towel in disgust because one specific trade did not result as expected. If all SELLs resulted in re-BUYs at a lower level, then the Dow Theory (and trend following ) would self-destruct as all traders would gravitate to the newly discovered money-making machine.

Trading is rewarding only for those that understand the game, and the odds, know the strategy thoroughly, and have the psychological fortitude to endure periods of underperformance. There are no shortcuts to success.


Tom Basso, featured in The New Market Wizards, a legendary trend follower, published one book called “Panic Proof Investing” to teach his clients what to expect of a trend-following fund and not panic at the first spell of underperformance. His book is a psychological “fortifier.”

OK. Let’s assume you have read this post so far and are mentally equipped to deal with losing trades, modest winning trades, and periods of underperformance. You may be asking yourself: How much can I make?

The Dow Theory for the 21st Century (DT21C) has outperformed BAH by 3.21% p.a. Drawdown was reduced by ca. 50%. So, in risk-adjusted terms, the DT21C trounces BAH. Many readers will think that a 3.21% annual outperformance is too little. Well, it wouldn’t be that much if we were doing leveraged short-term trading and/or trading specific stocks, not the Indexes. The only way to target higher returns is by doing more trades (but there will be more noise and less signal, so no free lunch), leveraging, sometimes shorting, and picking specific stocks. You will increase your bottom line if you are skilled, but the time commitment will rise exponentially.

However, to beat BAH by more than 3%, without leverage, with less than a trade per year, and only long, is quite a feat. By definition, if we measure performance based on years, making more than 3% annually with trades that last approximately one year is remarkable. As I explained HERE, there are ways to push the envelope without resorting to (1) overtrading, (2) leverage, and (3) shorting. Going the extra mile for additional outperformance not only increases the bottom line but also serves to shorten the periods of underperformance. The higher the annual average outperformance v. BAH, the more likely the spells of underperformance will be short lived. Accordingly, one of my real-money portfolios which I show to my Subscribers is based on the Dow Theory for the 21 Century (as a trend filter) coupled with high relative strength ETFs. The system targets 5% overperformance v. BAH but, more importantly, to shorten the periods of underperformance (which is not a lack of performance, merely less performance).  

So, I am convinced that the DT is a great way to outperform the market with less risk. However, we should know what to expect first and be willing to stay the course. Knowledge is power. But knowledge requires effort. Reading this blog is an excellent place to start.  

Do you want to know more? Go to the free area of our website, where you'll find more resources:



Manuel Blay

Editor of thedowtheory.com