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Dow Theory Update For July 10 :Dissecting The Current Secondary Reaction In Stocks

Jul. 10, 2013 4:55 PM ETSPY, DIA, IYT, GLD, SLV, GDX, SIL
Manuel Blay profile picture
Manuel Blay's Blog
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Seeking Alpha Analyst Since 2012

Co-Editor of the top-ranked investment  Letter  thedowtheory.com

Investor and Trader As an investor I'm deeply influenced by Dow Theory, especially by the book "The Dow Theory for the 21st Century". I focus on the primary trend (1-2 years). My trading is short-term based (avg trade duration 4-5 days).

In addition to US stock indexes, I have successfully expanded the application of the Dow Theory to precious metals, their miners, and US interest rates. The Dow Theory is a more accurate timing device that moving averages, breakout systems, etc.

Stocks Take A Breather. Precious Metals Languish

Yesterday I announced the secondary trend of the market had turned bullish. This is tantamount to saying that there is an ongoing secondary reaction against the primary bearish trend. Well, let's dig deeper into it.

As I wrote here, please bear in mind that appraising secondary reactions is not math. Rhea wrote:

"Probably no two students would agree on any rule for selecting and tabulating the important secondary reactions."

All Dow Theorists, past and present, agree that gauging secondary reactions is not an easy feat. Furthermore, it appears that its rules (i.e 10 trading days, etc.) are bent quite often. Even Rhea when he conducted a study of all secondary reactions that occurred until 1931, he labeled as "secondary reaction" movements that didn't reach 10 trading days, much less the 3 weeks times he advocated in his book. Other practitioners drop the retracement requirement altogether (i.e. Martin Pring). Personally, I find that the Schannep way strikes a decent balance between respecting basic Dow Theory rules (i.e. minimum time requirement, minimum extent requirement and technical requirement) and responsiveness (i.e. by accepting 10 days and even less in very exceptional circumstances).

Dow Theorist Schannep satisfies himself with at least 10 calendar days with at least 8 trading days as the average of all indices (Industrials, Transports and SPY). I tend to demand at least 10 trading days in at least two indices, even though, I can easily bend my own rule and follow Schannep. All in all, there are not hard-and-fast rules when it comes to appraising secondary reactions.

In any instance, the requirements to declare the existence of a secondary reaction according to Schannep's Dow Theory "flavor" or even my own "flavor" (10 trading days in at least 2 indices) have been fulfilled, since the SPY, Transports and Industrials rallied 10 trading days from 06/24/2013 (primary bear market lows) until 07/09/2013 (last recorded closing highs).

For a secondary reaction to exist, it is further required that at least two indices rally more than 3% from the last recorded closing lows.

Here you have the percentages made by each index:



Closing high 15300.34 6440.47 165.13 07/09/2013
Closing Low 14659.56 5990.79 157.06 06/24/2013
Pctg rally 0.04371073 0.075061887 0.05138164  

Therefore, we see that both the Transports, the Industrials, and the SPY have rallied more than 3% in the last few days.

So on 07/09/2013 both the time requirement and the extent requirement have been fulfilled, and, accordingly, we label all the price action that occurred since the last recorded lows (06/24) as a secondary reaction against the primary bearish trend.

So now, we have within striking distance two alternative primary bull market signals:

a) On the one hand, the last recorded primary bull market highs (blue horizontal lines on the chart below). As I explained yesterday, a breakup of such closing highs flashes a new primary bull market signal. In case you are asking yourself whether such a breakup is "orthodox" according to the Dow Theory, I'll tell you that "yes"; it is "orthodox" under Dow Theory, and Rhea, and Schannep explicitly wrote about it, even though it is very infrequent. Since I have personally examined all the Dow Theory record, I can safely say that less than 10% of the primary bull market signals are flashed by this particular setup. A future post in this Dow Theory blog will occupy more in depth with all primary bull and bear market signals.

b) On the other hand, the secondary reaction highs, in case at least one index undergoes a pullback exceeding 3% followed by a breakup of the 07/09 closing highs (upper boundary of the blue rectangles).



The blue rectangle highlights the current secondary reaction against the primary bearish trend. The horizontal blue lines show the last recorded primary bull market closing highs. If such price level is broken up, a new primary bull market would be signaled


The SPY closed up by a cent. The Industrials and Transports closed down.

The primary trend is bearish for the reasons explained here, and further explained here.

The secondary trend is bullish, as has been explained above.

Today's volume was lower than yesterday's. Given that the SPY closed up (by a cent), and the Nasdaq closed solidly up, I'd tend to say it was a mildly "up" day. Thus, volume has not supported higher prices, which has a bearish connotation. The overall pattern of volume continues bearish.

Gold and Silver

SLV closed down, and GLD closed up. The primary trend is bearish, as explained here and reconfirmed bearish here; the secondary trend remains bearish too.

GDX and SIL, the gold and silver miners ETFs closed down. The primary trend is bearish, as explained here and reconfirmed bearish here; the secondary trend remains bearish too.

Eventually, one of these primary bear market re-confirmations will be proven false. In the meantime, it is better not to fight the trend, and wait for a primary bull market signal in order to make a commitment on the long side.


The Dow Theorist

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