Not everything promoted as "Dow Theory" is the correct Dow Theory
In four past posts (here, here, here, and
here I debunked what I believe are incorrect and underperforming
interpretations of the Dow Theory. The Dow Industrials' newer highs have
sparked claims from various "Dow Theory experts" that a new Bull
market has emerged, which implies that all of them consider that on July 2023
we were still in a bear market. Lo and behold! I will not
give names, as I despise the sin but not the sinner. Google alerts have been rife
with “Dow Theory” news of late.
So, what do I consider to
be “heretical” (or “plain wrong”)?
Higher highs in July 2023 by the Dow Industrials
prompted many market observers to proclaim that a Buy signal (a new bull
market) had been triggered. The issue is that many don’t agree as to what highs
are relevant. Some talked about the 2023 highest highs being taken out. Others said that the relevant highs to penetrate were the
11/30/22 highs. So, to start with, there is ample disagreement as to what constitutes
a relevant high. As a reminder, sound Dow Theory has it that the last closing
highs that precede the onset of a secondary reaction (pullback) are the
relevant highs to be pierced. 52-week highs and monthly highs (I have also seen
this in
the past ) are irrelevant to the Dow Theory and misleading.
Hence, to signal a new
bull market, we need the last recorded highs (those that preceded the start of
the secondary reaction) to be broken topside. It does not matter whether they
are just 20 days or 2 years away. This is precisely what makes the Dow Theory
so adaptive to the market environment.
However, irrespective of
the right highs to be considered, all of them were wrong because the “classical”
Dow Theory buy signal was triggered on
11/8/22 and was 14.31% lower than the S&P500 levels on 7/17/23. Of course, being so late in discerning the buy signal
will inevitably result in underperformance. No wonder the Dow Theory is often
blamed for being late.
Now, let's explore
the proper way to apply the Dow Theory and how we became bullish (and invested)
when everyone was still bearish.
Following
the 9/27/22 lows for the Dow Transportation at 11,999.40 and 9/30/22 for the
Dow Industrials at 28,725.51 (Step #1 in the Table below), there was a solid
rally until 10/28/22 (Dow Industrials) and 10/31/22 (Dow Transportation) (Step
#2) which qualified as a secondary reaction (three or more weeks & >= 3%
confirmed). A pullback followed until 11/3/22 at 32,001.25 (Dow
Industrials) and 11/2/22 at 13,094.43 (Dow Transportation),
which completed the setup for a potential BUY (Step #3).
On
11/7/22, the Dow Transportation broke topside its 10/31/22 bounce highs (Step
#2), and on 11/8/22, the Dow Industrials confirmed (Step #4), triggering the
new Buy signal.
The
Table below contains all the price action that unfolded from the September
market lows (Step #1) until the final breakup (Step #4).
The chart below
illustrates the data from the table above. After the bear market lows in
September (Step #1), a rally ensued, satisfying the requirements for a
secondary reaction: 15 or more trading days of advancing prices and >=3% on
both Indexes (Step #2, blue rectangles). Following this, a pullback (Step #3)
exceeding 3% on at least one Index completed the setup for a Buy signal.
The confirmed
breakout of the secondary reaction highs (Step #2) triggered the BUY on
11/8/22. The last highs were on 11/30/22 @34,589.77 for the Dow Industrials
and on 2/2/23 @ 15,640.70 for the Dow Transportation. Subsequently, a new
pullback qualifying as a secondary reaction unfolded.
On 7/10/23, the
Dow Transportation surpassed its 2/2/23 highs, and the Industrials followed
suit on 7/18/23, reaffirming the "old" 11/8/22 BUY and bullish
situation. However, there was no new bull market or Buy signal on 7/18/23.
The
same mistakes were made during the bear market that I signaled on 2/22/22, and
several months later, many Dow Theorists proclaimed that the bear market was
triggered when it was nearing exhaustion (see this
post).
This article written by Jack Schannep several years ago, provides insight into the negative impact on performance caused by errors in interpreting the Dow Theory.
In any
instance, what I have been discussing above is the “classical” Dow Theory. It
works, it outperforms, and notably, it reduces drawdowns, as I explained here.
You can find the complete “classical” Dow Theory
record, which has been verified in "Technical
Analysis of Stock Trends,"
8th Edition, by W.H.C. Basseti (pages 49-51). The record can be accessed here: https://thedowtheory.com/resources/traditional-dow-theory/complete-dow-theory-record/
However, there is an even better Dow Theory “flavor”: The Dow Theory
for the 21st Century crafted by Jack Schannep. He's taken this
time-tested theory to new heights by adding a third Index (the S&P500) and
shortening secondary reaction time, resulting in an ultra-responsive version
with reduced drawdowns and solid outperformance against Buy & Hold. So, what about the trend when appraised by the Dow
Theory for the 21st Century (aka. Schannep’s Dow Theory)? It is also bullish
(and from a long time ago, too). On June 30th, our portfolio was up
by +11.4%.
Yet more: We are now targeting 5%
p.a. outperformance with our just launched Dow Theory-based ETF trading
system, as explained here.
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Sincerely,
Manuel Blay
Editor of thedowtheory.com
