Thursday, July 20, 2023

Dow Theory Update for July 20: Heretical Interpetations of the Dow Theory (II)


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:


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.

Do you want to know more? Become a Subscriber, and you’ll get access to a wealth of information (i.e., access to our Letters since 1962 and their concomitant trade recommendations, the power of the consumer confidence report as a timing device, the special report about the yield curve, how to calculate profit objectives that work, and much more). More importantly, you’ll be punctually updated through our email service of any change in trends and the specific ETFs making up our Dow Theory on steroids portfolio. Not accidentally, our Newsletter has consistently been ranked among the top investments Letters.


Manuel Blay

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