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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: A New Answer To The New Low Observer (NLO)  3 comments
    Mar 2, 2013 9:27 PM | about stocks: SPY, DIA, IYT

    You can find a more readable and better formatted version of this post here:

    The New LowObserver (NLO) is an avid student of the markets. Its website contains a wealth of information, which spans many subjects (Dow Theory, specific stocks, book list, market observations, etc.)

    NLO posted a comment in my Seeking Alpha blog in the past which resulted in my post "An Answer to the New Low Observer (NLO)" which you can find here.

    Last February 25, NLO produced a new comment to a new post of mine in my Seeking Alpha blog. Even though I tried to address the issues raised by NLO as a simple reply to the comment, I decided that the breath of topics raised were worth being dealt with in a separate post. This is what I am doing right now.

    Basically, the allegations put forward by the NLO are as follows:

    · Positions taken in accordance to the "classical/Rhea" Dow Theory last at least 2-4 years.

    · All positions taken in accordance to the "classical/Rhea" Dow Theory result in profits.

    · The positions hitherto suggested in this Dow Theory blog have lasted substantially less and have resulted in modest profits or minor losses.

    · This is likely to be caused by the Dow Theory "flavor" I use (basically Schannep's with my own minor departures).

    · I should re-appraise my Dow Theory "flavor" as the trends it detects are not strong enough to result in substantial profits.

    I am editing and simultaneously expanding a chain of comments and replies posted by both the NLO and truly yours in my Seeking Alpha blog.

    Those interested in getting the full chain of comments are advised to go here because this post is not exhaustive, and some issues were exclusively dealt with by both the NLO and I in the Seeking Alpha blog.

    On the other hand, some issues are subject to a more comprehensive explanation in this post, which includes the results of a thorough investigation of all Dow Theory signals since 1897 to date. Hence, lovers of the Dow Theory should read both this post, and the comments chain in Seeking Alpha.

    I am answering each of the objections raised by the NLO as if I were answering an email. Thus, I have inserted my answers into the text of the original NLO's comment with a different font and red color to make it easy to distinguish objection and answer.

    My clarifications are made in the spirit of deepening our knowledge of the Dow Theory and are not intended to be contentious or dismissive of diverging opinions. After all, markets function through the existence of different opinions. Otherwise, we all would be selling or buying at the same time.

    Have a wonderful weekend.


    The Dow Theorist


    This is getting back to the question of "what has the average length of the primary trend been historically?"

    As we've maintained, primary trends (bullish) historically last at least 2-4 years (as found here:

    In all the work on the topic of Dow Theory, I have not seen (showing my lack of vision on the matter) a primary trend last only a month or two at a time.


    Let's focus on the "classical/Rhea" Dow Theory and let's look at the whole track record as contained in Schannep's book (pages 26-29) and his website. Until October 1956, the Dow Theory record reflects the reconstruction made by Edwards &Magee and from October 1956, until now, the record was recapitulated by Schannep by applying "classical/Rhea" Dow Theory rules.

    The Dow Theory records spans 116 years, since it starts in 1897.

    Let's take a look at the results:

    The average duration of each transaction taking according to the classical Dow Theory lasted 712 days. This is slightly less than 2 years.

    The median duration amounts to 565 days, which is roughly 1.5 years.

    The shortest investment lasted only 60 days (year 1990).

    The longest investment lasted 2799 days (secular bull market 1900-1998).

    All the instances lasting less than 180 days (ca. 6 months) occurred during secular bear markets (save one position, which lasted only 60 days and was taken in 1990 within the secular 1982-1999 bull market). Therefore, when assessing the probable duration of a new primary bull market, it is advisable to try to put the nascent trend in context. If it is born within a secular bull market, it is likely an "above average" duration. If, conversely, the market is under the spell of a secular bear market, the odds favor shorter trends. While I acknowledge than in real time not so easy to label the market a "secular bullish or bearish", we can make our guesses.

    Thus, we can conclude:

    1. The average duration of the positions taken according to the classical/Rhea Dow Theory last ca. 2 years on average. If we took the mean, we'd derive shorter time spans.

    2. While occasionally we may encounter trends (or better said, positions within a trend) that last 4 years or more, this is by no means the rule but rather the exception.

    3. Shorter trends (and accordingly positions) tend to occur during secular bear markets. In technical parlance, we would say that the market is prone to false breakouts.


    Additionally, I have not seen a primary trend where it came out with a negative return in real time (whether acted upon or not).


    Neither have I. By definition, even the smallest trend will show a profit if we measure from bottom to top. We shouldn't confuse, though, total duration of a bull market with total duration of the investments made following primary bull market signals. This aspect was explained ad nauseam here.

    However, the issue at hand is whether the trend detected by the Dow Theory has sufficient strength or magnitude to result in profits allowing for the inherent delay of all timing systems in getting in and out of the trend.

    I guess that what is really meant is that all positions/trades/investments made according to the "classical/Rhea" Dow Theory resulted in profits.

    Well, let's look at the record:

    9 transactions made according to the Dow Theory resulted in losses for the investor. 7 such trades took place under secular bear markets. 2 took place under secular bull markets.

    Here you have the details out of the spreadsheet:

    Date Dow Industrials Pctg lost



    SELL 13/05/1940 137.5 -3.56291205
    SELL 26/04/1962 678.68 -3.96083037
    SELL 25/02/1969 899.8 -4.51226759
    SELL 26/01/1970 768.88 -10.6244479
    SELL 19/10/1978 846.41 -2.31965009
    SELL 03/08/1990 2809.65 -4.27706554
    SELL 25/06/2002 9126.8 -4.8054137
    SELL 29/09/2008 10365.45 -19.3310017
    SELL 04/06/2012 12101.46 -1.56612982

    The "classical/Rhea" Dow Theory produced 38 transactions during the 116-year time period. Since 9 trades were losers, 76% of all investments made resulted in profits. However, 24% of the trades resulted in losses.

    Therefore, as it should be expected, there is no holy grail. The classical Dow Theory also experiences rough patches. Furthermore, if we consider that it is more likely than not (valuations, gold/dow ratio, etc.) that the secular primary bear market is not over yet, then we should conclude that all investments made according to the primary trend, as detected by the Dow Theory are facing considerable headwind. Should we fold? No, we have to take all signals, but being very aware that on a secular basis, we are not under the most favorable market environment for stocks. If the investor is very sure of his "secular" assessment, then what I wrote here, with all caveats, may be heeded:

    "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."


    Furthermore, your recent work on the "classical" Dow Theory showed exceptional performance compared to buy-and-hold BUT over periods ranging from a year or more.

    Even though I question any interpretation that shows only a year for a Dow Theory primary trend, I cannot argue if the beginning and ending period showed a return that is positive on the representative index.

    I feel I was not clear enough in my posts concerning the assessment of the Dow Theoryperformance. This is why the subtitle of the first post of this "performance" saga bore the name "Evaluating performance on a year-end basis"

    In the same vein, I wrote:

    I have the Dow Theory versus buy and hold (of the Industrials) record from 1896 to 2011. So we can compare on a year-to-year basis (year-end end figures) how buy and hold fared versus the Dow Theory. Thus, in a given year, buy and hold may have delivered +10% whereas the Dow Theory merely returned +3% and vice versa. We take as our reference for a buy and hold investor the Dow Jones Industrials.

    Therefore, my studies didn't imply that the Dow Theory "trades" or "investments" lasted one year, but merely I took the profit or loss made on 12/31 by the Dow Theory and buy and hold. If the Dow Theory was fully invested during 4 years, then I took the unrealized profit or loss accrued at year-end. If the Dow Theory resulted in a short-lived trade and the investor was in cash on 12/31, I merely reflected the profit or loss accrued during such a year.


    As an example, our Dow Theory analysis indicated that the primary trend was bullish on July 23, 2009. At the time, the Dow Jones Industrial Average was at 9,069.29. When the primary trend changed to bearish on August 2, 2011, the Dow was at 11,866.62, an increase of +30% above the July 23, 2009 bullish primary trend. Since August 2, 2011, the Dow has fallen as much as -12% (in two months after that call) and gained +15% as of 2/24/2013 (annualized return of +10.33%).


    I agree. Most followers of the Dow Theory agree as to the existence of a primary bull market during that time whose end was signaled on 08/02/2011. True to its protecting function the Dow Theory spared investors for incurring further losses as you rightfully note.


    However, in the time that you've published on Seeking Alpha you've indicated primary trends, two full bull and bear primary trends for stocks and one full primary trend for gold, which have all resulted in negative final numbers.


    With all due respect, wrong as to the number of trends I signaled and equally wrong as to the statement that all trends signaled ended up in losses. Facts are:

    As far as stocks are concerned, I signaled in my blog the existence of only one primary bull market. The primary bull market started on June 4, 2012 and was signaled on June 29, 2012. The primary bull market topped on October 4, 2012 and the exit was signaled on November 16, 2012.

    The position taken according to such a trend ended in modest profits as any reader can see here:

    By the way, from June 29 (buy date) and November 16 (sell date), four and a half months elapsed.

    On January 2, 2013, I signaled the existence of a new primary bull market. Until now, such bull market remains in force with unrealized gains, and hence it is premature to label my market call as a winner or a loser.

    Bottom line: As far as stocks are concerned, I have called and completed only one bull market, not two, and the one I called ended up with modest profits not losses.

    As to the bear market, we should bear in mind that never ever I advised to short the market. The sell signal merely implied to sell out of stocks, not to sell short stocks. Thus, no "losses" can be ascribed to my calling a bear market. The bear market was merely the sell signal that put an end to the only bull market Ihad previously called. Furthermore, the average duration of bull markets (ca. 2 years) is not applicable to bear markets, which are short-lived in general. I made this clear here.


    Additionally, you readily admit, "I am very aware that recently this Dow Theory 'flavor' has signaled too many signals in too short time." Isn't it worth reconsidering the primary trend analysis that results in signals of less than 6 months?


    It is neither an aberration of the market, nor an error of this market practitioner to spot primary trends that last less than 6 months.

    Thus, there were 6 instances (out of 38 trades since 1897) according to the "classical/Rhea" Dow Theory that resulted in signals of less than 6 months. Here you have the list:

    Date Dow Ind Pctg lost Time (days)



    SELL 25/02/1969 899.8 -4.51226759 147
    SELL 26/01/1970 768.88 -10.6244479 91
    SELL 19/10/1978 846.41 -2.31965009 135
    SELL 03/08/1990 2809.65 -4.27706554 60
    SELL 29/09/2008 10365.45 -19.3310017 164
    SELL 04/06/2012 12101.46 -1.56612982 164

    Therefore, 15.7% of the trades were short-lived. Please mind that only one such shorter-than-average bull market occurred within a secular bull market. All of them occurred under secular bear markets.

    Furthermore, it should be stressed that these 6 shorter bull markets were detected according to the "classical/Rhea" Dow Theory. Thus, I see no mistake or need to reconsider the way I applied the Dow Theory. Of course, I was aware that the bull market was short-lived, but this is well within the limits of the past observations of the Dow Theory.

    Having said this, it is true that the "Schannep's flavor" of the Dow Theory results in trades lasting on average less than those made following the Dow Theory (as per Schannep's book, page 101). Consequently, the positions taken within trends determined by Schannep's flavor last on average 13 months. However, this is a long shot from being a short term trader. Furthermore, there are thoughtful studies (i.e. M.J. Mauboussin, "More than you Know. Finding Financial Wisdom in Unconventional Places",Columbia University Press, 2006, p. 126) that suggest that the accelerating rate of industry changes means that the investment horizon for the investor (i.e. portfolio turnover) must be shortened accordingly. If we bear in mind that Schannep's is the best performer Dow Theorist, we should conclude that there is nothing wrong with slightly reducing the average duration of each position. Schannep in his book is also convinced that modern accelerated times require a somewhat more reactive approach.


    While we disagree about the length of what a primary trend is, if it results in gains of +0.30%, then those who are uninitiated by the breadth of Dow Theory and its benefits may end up thinking (justifiably) that from a cost/benefit standpoint, it may be more work than it is worth to follow Dow Theory for that kind of return. After all, a 1-year CD could have garnered the same annualized return without all the work.


    Trends are what they are, and we humbly have to take what the market gives us. If a trend is weak, there is no way in the world to extract big profits out of it. We go with the flow, but we cannot force the flow to suit our wishes. As far as I know, neither the NLO, nor other Dow Theorists have been able to extract significant profits from the stock market or to beat buy and hold in the last six months (time I have been blogging and making my analysis of the markets). Classical Dow Theorists were on the sidelines during this period (which is nothing wrong, as I have nothing against the classical/Rhea Dow Theory) and only on January 18, 2013, a primary trend was signaled according to the "classical/Rhea" Dow Theory, which was echoed here.

    Thus, there have been 3 instances where the "classical/Rhea" Dow Theory returned modest profits below 5%. Here you have the list:

    Date Dow Ind Pctg Profit

    SELL 01/06/1903 59.59 0.25235532
    SELL 14/01/1913 84.96 3.72359907
    SELL 23/03/1973 922.71 0.15521883

    If we bear in mind that, in addition to these 3 "sub par" trends, there were 9 instances where the investor lost money, it stands to reason that many trends, even when detected according to the most orthodox Dow Theory, fail to extract a meaningful profit from the trend.

    With all due respect to the NLO, there is no failing in the way I am applying the Dow Theory, unless one subtly wants to excommunicate Schannep's version, which is akin to excommunicating the best performer of the pack.

    As to the uninitiated that may be demoralized by the lack of performance shown by the Dow Theory in the last few months, I have a few words to say.

    If any Dow Theory amateur is deterred from adopting the Dow Theory because one transaction was not able to beat 1-year CD, this amateur will remain an amateur for ever because he lacks the wits to understand (and the stomach to digest) the nature of long periods of underperformance, which is the price to pay for long term outperformance (both in absolute returns and risk-adjusted). If any single trade resulted in guaranteed money, then technical analysis and the Dow Theory would self destruct. Everybody would be following it. Precisely, what separates the winners from the quitters is the ability to understand the nature of underperformance, as merely the price to pay to reduce significantly risk and even outperform in the long run.

    Stocks: SPY, DIA, IYT
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Comments (3)
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  • New Low Observer
    , contributor
    Comments (2412) | Send Message
    Greetings Manuel,


    Thanks for your follow-up on this topic. It is very interesting and very clear that you are dedicated to the topic of Dow Theory. We've taken your commentary in the spirit it was presented and thoroughly enjoyed it.


    There is one point that must be addressed immediately, you said:


    "...As far as I know, neither the NLO, nor other Dow Theorists have been able to extract significant profits from the stock market or to beat buy and hold in the last six months..."


    As measured by the closing price of August 31, 2012 (August 2012 statements) to February 28, 2013 (February 2013 statements; last six months), the return of accounts managed by us had the following performance:


    Port. #1: +9.97%
    Port. #3: +11.18%
    Port. #4: +9.82%
    Port. #5: +11.57%
    Port. #6: +12.36%
    Port. #7: +12.36%


    Average: +11.21%


    Dow: +7.36%
    S&P: +7.69%


    Our portfolios generated these returns without additional funds added and with nearly 50% in cash during the entire six month period.


    Again, this was done within what we've considered a Dow Theory PRIMARY bear market since August 2011. As Dow has said:


    "Even in a bear market, this method of trading will usually be found safe, although the profits taken should be less because of the liability of weak spots breaking out and checking the general rise."


    Such is the method that we've applied to garner the 6-months gains described above.


    4 Mar 2013, 01:09 PM Reply Like
  • Manuel Blay
    , contributor
    Comments (348) | Send Message
    Author’s reply » Congrats. It clearly shows you are great investors, since most of the fund managers had a very hard time in outperforming the S&P during this time period. The final goal is not to get lost in endless discussions but in being able to protect capital and, with some luck and knowledge, outperform the markets. This has been achieved by the NLO.


    Since you show 7 portfolios, I deduct:


    a) it is not plain Dow Theory (of any flavor you take), as it is nimpossible o obtain 7 divergent results.


    b) It has been made by picking up specific stocks (VERY well chosen) and not the indices, which is what I and most Dow Theorists of the “classical/Rhea” or Schannep persuasion follow for benchmarking.


    The sentence you quote from Charles Dow refers to the general principle of buying value, which may prove profitable even under adverse conditions. Charles Dow distinguished between two ways of investing: (a) one based on values, as you rightly note; (b) another one based on trends using stops for pprotection,which later Rhea systematized and refined (or perverted according to Schaefer).


    S.A. Nelson (Chapter VI of "The ABC of Stock Speculation) based on Charles Dow editorials makes this distinction between these two forms of investing.


    What we have been debating here was the "classical/Rhea Dow theory," which is not concerned with values but with trends. Thus, with all due respect, NLO is mixing concepts.


    I am not saying that finding good value stocks as per Dow's guidance is futile. I acknowledge NLO's investment acumen by achieving such outstanding results.


    However, what we have been discussing here was the "classical/Rhea" version of the Dow Theory (based on trends) and not the writings of Charles Dow based on finding good values. To put in bluntly: It is like comparing the performance of a value investor against the performance of a trend follower.


    Thus, an apples to apples comparison and elementary fair play require that:


    a) We compare “equals” as to the method of investment (i.e. Dow Theory as trend following and not Dow's writings as a value investor).


    b) We compare performance achieved with indices (i.e. SPY or DIA) in order to benchmark and not indices with stocks.


    4 Mar 2013, 05:23 PM Reply Like
  • New Low Observer
    , contributor
    Comments (2412) | Send Message
    Greetings Manuel,


    Thanks for your commentary on this topic. It is very interesting.


    Regarding some of your points, you said:


    "a) it is not plain Dow Theory (of any flavor you take), as it is nimpossible o obtain 7 divergent results."


    There isn't a divergence between the portfolios, in fact, all of the portfolios listed are correlated in that they all increased in value. However, the distinction is in the objective of the portfolios, some are for lower risk holdings (retirement accounts), while other accounts are for higher risk holdings (i.e. gold stocks etc.). Additionally, the amount of funds used is substantial, thereby not allowing for entries and exits on a single price.


    Dow also speaks of a concept of “seeking fair profits.” We’ve commented on this matter extensively since it is very distinct in aiding anyone who wishes to understand how trading, as described by Dow, works. It is a concept that helped us to end 2008 with double digit gains while only going long stocks and not shorting nor using derivative products. We’ve simply applied Dow’s point of being able to make money in bear markets and “seeking fair profits” as tools to help us succeed in the market, so far (could end any day now, so we’ll have to accept that reality).


    You also said:


    "b) It has been made by picking up specific stocks (VERY well chosen) and not the indices, which is what I and most Dow Theorists of the “classical/Rhea” or Schannep persuasion follow for benchmarking."


    Before there were indexes to trade, almost 92 years was spent with Dow Theorist’s having to buy and sell individual stocks.


    When Alfred Cowles attempted to refute the value of Dow Theory he said “When bullish it was assumed that he bought equal dollar amounts of the stocks included in the Dow Jones railroad and industrial averages…(Econometrica. December 31, 1932. Page 315).” Never did he say that Hamilton bought the (DIA) or (IYT) etfs.


    When Robert Rhea gave bullish recommendations in his newsletter “Dow Theory Comment”, he never said buy the index, he recommended individual stocks. The same goes for Schaefer when he was bullish on the market. On page 158 of his book “How I Helped More Than 10,000 Investors to Profit In Stocks,” he lists individual stocks not the indexes for his recommendations. The same goes for Richard Russell and almost any Dow Theorist prior to the creation of Index ETFs.


    From our work on the topic, Dow Theory is about values. We examine values (fundamental attribute) when an individual stock achieves a NEW LOW (technical attribute). Once a new low is accomplished, we consider the fundamental values of the company to determine if the declining TREND will reverse. Depending on the fundamental values and the prospects for the trend to reverse, we either buy or review another company.


    The trend for the overall market works in a similar fashion. Based on the work of Dow and the many Dow Theorists that followed, we determine if the trend is primarily bearish or bullish. There are clues to this matter based on various historic fundamental benchmarks which confirm or refute the indication of the technical signals of Dow Theory.


    From our experience, Dow Theory isn’t simply about lines going up or down, it is rooted in economic fundamentals which Dow wrote about more often than he did on the topic of stocks and how they are traded. Therefore, values AND the trend of stocks are equally important, not separate and mutually exclusive.


    However, if your interpretation of Dow Theory requires that you have primary trends occur over periods of less than a year then it must have merit.


    Thanks for thoughtfully engaging in this topic, we really appreciate it.


    5 Mar 2013, 03:04 AM Reply Like
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