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Manuel Blay
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Trader and investor. My trading is short-term based (avg trade duration 4-5 days). As investor I'm deeply influenced by Dow Theory
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Dow Theory Investment
  • Dow Theory Special Issue: Assessing The Current Primary Bull Market Signal  3 comments
    Jan 7, 2013 4:38 PM | about stocks: SPY, DIA, IYT

    If you are a follower of this Dow Theory blog, you know that on January 2, a primary bull market in stocks was signaled. You can find the details here.

    Well, today, I'd like to expound the intricacies of the current bull market signal.

    First of all, on January 2, the new bull market was signaled. However such new bull market was on its way since the bear market lows of 11/15/2012. In other words, the market did not turn bullish on January 2, but on 11/15/2012. As with any timing device, the Dow Theory "detects" the existence of a new bull or bear market with some lag. No timing system is able in "real time" to spot the emergence of a new trend. However, as I have previously written in this Dow Theory blog, the Dow Theory does a good job at signaling new bull and bear markets in a timely fashion. As I wrote in my post "Revisiting the 1987 crash", which you can find here, "the Dow Theory tends to do a remarkable job at getting investors out of investments on a timely manner". By the same token, the Dow Theory also excels at signaling new bull markets close enough to the bottom.

    How much has won the SPY since its market lows of 15/11/2012?

    On 15/11/2012 the SPY closed at 135.7.

    On 02/01/2013, day when the primary bull market was signaled, the SPY closed at 146.06. Thus, the SPY won 7.63%. As a result, it took a price advance of 7.63% for the Dow Theory to signal the onset of a new primary bull market. This is pretty close to the bottom.

    Where lays the Dow Theory stop?

    I have written extensively about the Dow Theory trailing stop here.

    Our initial Dow Theory stop lies at the 15/11/2012 lows. This implies a loss of 7.63% in case the market would start to fall down in earnest without any intervening secondary reaction. Normally, this potential loss is a worst-case scenario. If the market advances and develops a secondary reaction, then our exit point will be lifted upwards.

    How long is supposed this new bull market to last?

    Rhea wrote in 1932 that:

    "there is no known method of forecasting the extent or duration of a primary movement"

    Thus, anything can happen. It may be stillborn (if the market stages a powerful decline that violates the 11/15/2012 lows), or it may last one or even two years. Nobody knows.

    However, we do know that statistically, primary bull markets tend to last an average of one year or slightly more.

    Within this context, it is worth bearing in mind what I wrote on January 2:

    Firstly, "average" means "average." Thus, it is not expected that every Dow Theory primary market is going to match exactly the alleged "average". Some primary markets will last longer than average (i.e. 1-2 years in bull markets; 6 months in bear markets) whereas others will last significantly less. So it is possible to see bull markets exceeding 6 years as it is possible to see bull markets fading after some few months.

    Secondly, the distribution of the duration of primary markets around the average greatly varies according to the secular trend. In other words, when a secular bull market sets in (as we witnessed from the early 80s until 2000) primary bull market signals tend to last longer than average. Of course, it is not so easy "in real time" to ascertain the existence of a "secular" bull market. However, once the secular bull market is clearly over the pattern that emerges is longer than average bull markets.

    Personally, I believe that we are undergoing a secular bear market since the year 2000; thus, it is not surprising to see primary bull market swings that end prematurely.

    Thus, I wouldn't be surprised to see this primary bull market suffering a premature death. However, one thing is clear to me: Even under secular bear markets and, accordingly, with greater likelihood of shorter and less profitable than average primary bull markets, the Dow Theory manages to extract profits off the market and, more importantly, keep the investor safe. I am not making this up. As you know, I've been strongly influenced by Schannep's Dow Theory "flavor." Consequently, we only have to look at Schanneps's publicized track record to see that during the current secular bear market that started in the year 2000, the Dow Theory (at least as interpreted by Schannep, who, at the same time, resembles Rhea) has managed to make over 6% annually (exclusive of dividends) whereas the SPY is basically flat.

    The bottom line is: We shouldn't outsmart the Dow Theory, and we must follow all primary bull and bear market signals irrespective of the secular condition of the market. 6% annual is quite a feat if we take into account that for most investors the last 10 years have been a lost decade. Furthermore, such remarkable out performance has been achieved with smaller draw-downs. Thus, the Dow Theory greatly improves the risk-adjusted profile of the portfolio. Please read my post "Why I like timing? Why I love the Dow Theory as a capital protector?", which you can find here, for a more in-depth explanation of the role played by the Dow Theory in protecting capital and improving the risk-adjusted performance.

    Of course, assuming that one is certain and not wrong, the secular condition of the stock market serves the investor in weighing the amount of capital to be invested in the stock market. Thus, as an example, if the investor reaches the conclusion that stocks are in a secular bear market or that valuations are not compelling whereas gold is in a secular bull market, the investor can allot less capital to stocks and more to gold.

    However, once a determined amount has been committed to stocks, the investor should not second-guess the Dow Theory primary bull (bear) market signals. Outperformance should come from allotting capital wisely between different asset classes (i.e. bonds, gold, and commodities) and occasionally (if one is in possession of the required skills) by selecting the stocks more likely to go up (instead of stock indices) within the framework of the Dow Theory signals.

    How far is supposed this bull market to go?

    Again, we have no way of knowing beforehand. However, gains averaging 30% and even 40% are not uncommon. However, we must bear in mind that we are within a secular bear market, so our primary bull market may fall short of expectations.

    Is this a "good" or a "bad" primary bull market signal?

    In my opinion, a "good" primary bull market signal entails a tight Dow Theory stop. In other words, it implies that the entry signal is not too far from the last recorded lows. The tighter the stop, the higher the risk/reward ratio.

    By definition, we don't know the market's future advance. This is unknown. Thus, the "reward" side of our risk/reward equation can only be guessed. My best guess is to take the average primary bull market signal gain. Thus, we can take a reward in the vicinity of 30%.

    And what about our risk? As we know our Dow Theory stop is situated at the 11/15/2012 lows, 7.63% below the entry price. While the actual exit price is never known in advance, we know that our worst-case scenario is not likely to exceed 7.63%.

    We also know that a Dow Theory stop of 7.63% is by historical standards a quite narrow stop. It is perfectly possible to see stops exceeding 10% and even 11%. It is not a narrow as the previous one we had (primary bull market signal of June 29, 2012 with a 6.25% initial Dow Theory stop which was subsequently raised as the market advanced and managed to exit the trade with a small profit) but, certainly, it is a narrow one.

    Therefore, our risk/reward ratio stands at 30/7.63 = 3.93.

    This is by all standards a very decent risk reward ratio. Even if the worst happens losses are likely to be contained.

    In a future post, I will list all the initial Dow Theory stop losses to show that anything below 9-10% is quite a narrow stop and hence presents a good investment/trading opportunity.


    The Dow Theorist

    Stocks: SPY, DIA, IYT
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Comments (3)
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  • New Low Observer
    , contributor
    Comments (2543) | Send Message
    Greetings Manuel,


    Your call on the secondary trend being bearish on October 5, 2012 was FANTASTIC. You hit the exact top in the market at that point in time (found here:


    However, as a student of the markets and Dow Theory, I find your January 7, 2012 posting to be perplexing on many levels as it relates to Dow Theory.


    First and foremost, You've indicated that although Dow Theory has turned bullish on January 2, 2013, the PRIMARY BULL MARKET trend actually emerged on November 15, 2012. However, when we revisit your November 16, 2012 posting titled “Dow Theory Update For Nov 16: Primary Bear Market For Stocks Signaled Today” (found here: we find that, as your title states, a PRIMARY BEAR MARKET had just begun. Furthermore, you go so far as to say in that article (11/16/2012) that October 5, 2012 was the actual beginning of the PRIMARY BEAR MARKET.


    When we review the Dow Theory analysis that followed October 5, 2012, we find that your view was that the market was in a PRIMARY BULL MARKET. This is confirmed by your October 10, 2012 article titled “Dow Theory Update For Oct 10: Secondary Trend For Stocks Turned Finally Bearish” (found here:


    Your concluding thoughts were:


    “Don't press the panic button. The market continues in a primary bull market, and a secondary reaction is something to be welcomed as it is healthy (like a summer storm). Markets cannot go up in a straight line. As to gold and silver, we cannot even talk of a secondary reaction. Don't forget that the action of October 4th, was very bullish for gold and silver. Remember what I wrote in this post.”


    Again, let’s be clear, your call on the secondary trend being bearish on October 5, 2012 was FANTASTIC. You hit the exact top in the market at that point in time.


    However, it would be disingenuous to “RETROCAST” your analysis by pointing to when the trend changed and then overlay Dow Theory on top of that and then say, “see Dow Theory was right.” It is an injustice to Dow Theory which is intended (based on the Hamilton/Rhea version) to track PRIMARY BULL MARKETS which tends to last from 2-4 years and PRIMARY BEAR MARKETS which usually last from one-third to three-fourths the preceding PRIMARY BULL MARKET.


    You have taken considerable care to justify your frequent calls of a primary bull and primary bear market with the following comments on January 2, 2013 (found here:


    “I am very aware that recently this Dow Theory ‘flavor’ has signaled too many signals in too short time. On June 4, 2012 (even though I was not blogging at that time), the Dow Theory flashed a primary bear market signal which was negated by a subsequent primary bull market signal on June 29. Later, on Nov 16, a primary bear market was signaled (11/07/2012 as per Schannep's). Some critics would say that such short-lived signals do not bide well with the claim that primary trends tend to last 1-2 years on average.”


    However, it would be hard to claim that “critics” are not in favor of such short duration primary moves in the market when those same individuals are deriving their view from the primary & secondary sources. Especially when the “criticism” is based on direct quotes from Charles Dow himself. The following are Dow’s own words on the concept of a primary market move:


    “We have frequently demonstrated that the stock market, while full of short fluctuations [also known as secondary reactions], has a continuing main movement [primary bull/bear market], which often runs in one direction for three or four years at a time.(source: Dow, Charles H. Review and Outlook. Wall Street Journal. September 13, 1900).”


    To proffer Jack Schannep or E. George Schaefer’s theory for your method of interpreting the markets is great, especially when it works. However, to suggest their strategy is Dow’s theory (as modified and then codified by Robert Rhea based on the works of William Peter Hamilton) brings legitimacy to the criticisms against Dow Theory. Worst still, RETROCASTING, referring to old data and changing your current view to fit what has already passed in contradiction to the real-time call you’ve made, is misleading at best.


    Another concern is the rationalizing of the idea that “…’average’ means ‘average.’ Thus, it is not expected that every Dow Theory primary market is going to match exactly the alleged ‘average’. Some primary markets will last longer than average (i.e. 1-2 years in bull markets; 6 months in bear markets) whereas others will last significantly less. So it is possible to see bull markets exceeding 6 years as it is possible to see bull markets fading after some few months.”


    Referring to the “bible” of technical analysis, Technical Analysis of Stock Trends by Edwards and Magee (1991 edition. Page 61 found here:, Dow Theory NEVER had a primary bull market that lasted less than a year from 1897 to 1957. According to the book Trader Vic II by Victor Sperandeo, Dow Theory had only two primary bull markets that lasted less than a year (3/31/38-11/12/38 and 4/8/39-9/12/39) from 1896 to 1989 (1997. Page 106). According to Jack Schannep’s book Dow Theory for the 21st Century, it is stated that the period from 1897-1956 had only one period when a primary bull market was less than a year (7/17/1939-5/13/40) [This data was derived from the 2001 edition of Technical Analysis of Stock Trends].


    However, under Schannep’s personal analysis of Dow Theory primary bull markets from 1954 to 1999, there were six periods when Dow Theory primary bull markets occurred in less than a year. The dates and performance are as follows:


    10/10/1961 to 4/26/1962: -3.96%
    1/11/1967 to 10/24/1967: +7.99%
    10/1/1968 to 2/25/1969: -4.51%
    9/28/70 to 7/28/1971: +14.89%
    6/6/1978 to 10/19/1978: -2.32%
    6/3/1990 to 8/3/1990: -4.28%


    Not surprisingly, the “average” performance of those periods that were less than a year was +1.30%. This suggests that the above dates need to be studied to understand how they were not accurate for the purpose of avoiding such short term indications.


    The review of the 3 different sources also tells us that Schannep’s approach is probably the least robust method to apply. After all, under Schannep’s approach, 5 of 18 Dow Theory primary bull markets generated negative returns by the time a “sell” signal was given. This means that only 72% of the bull market indications were correct. Contrast that with Sperandeo and Edwards & Magee’s 100% of bull market indications generating positive returns.


    Now, Schannep seems to believe that his interpretation is rigorous enough to withstand the test of time while generating positive returns to the investor. However, even if the Sperandeo and Edwards and Magee interpretation of Dow Theory are simply ex-post analysis, or RETROCASTS, wouldn’t it be better to see if their analysis is correct since we know for certain that Schannep’s 72% is inferior to the alternatives mention earlier.


    Again, this is simply an examination of Dow Theory as students of the stock market and the relevant sources on the topic. Your discussion of Dow Theory is certainly stimulating and I hope that the above points only further the discussion.


    8 Jan 2013, 03:19 PM Reply Like
  • Manuel Blay
    , contributor
    Comments (369) | Send Message
    Author’s reply » NLO,


    thx for commenting.


    You bring up many issues which I feel I can address. However, an in-depth answer takes time and cannot be done in a cursory manner. Thus, I will write in the coming days a special Dow Theory issue.


    I welcome the observations as they give us all the opportunity to become better investors.


    Readers of this Dow Theory blog stay tuned!


    9 Jan 2013, 10:08 AM Reply Like
  • Manuel Blay
    , contributor
    Comments (369) | Send Message
    Author’s reply » NLO and readers of this blog,


    you can find the answer to NLO's comment here:



    And also here if you want a better layout:



    thx to all and regards
    12 Jan 2013, 04:24 PM Reply Like
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