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Dow Theory Special Issue: How Good Is Schannep's Dow Theory At Picking Bottoms And Exiting Tops?

|Includes: DIA, GDX, GLD, IYT, SIL, SLV, SPDR S&P 500 Trust ETF (SPY)

Trends unchanged on stocks and precious metals.

On many occasions, and based on my observations of Schannep's Dow Theory primary bull and bear market signals, I have written that buy signals tend to be signaled at roughly 5-7% from the lows (bottom) and sell signals at around 5-7% from the highs (top).

I must confess that I didn't find the time to do the exact math and I was just giving a rough measure. Maybe I didn't because I know that we are just dealing with rough figures and not with mathematical certainties. I just needed to know that "buy" and "sell" signals tend to come quite close percentagewise from the bottom/top and that the average primary bull market swing has enough magnitude to account for the percentage points "lost" when getting in and subsequently when getting out.

Since we know that the average decline following the primary bear market signal is around minus 12.85% (more about it here and here), I always advocated for not second-guessing Dow Theory signals. While we cannot predict the outcome of any given signal, we know that in the long run the odds favor a new re-entry (buy signal) at a lower level that our exit price.

The math is simple: If following a primary bear market signal we can expect the market to further decline ca. 12.85%, and we "buy" at around 7% from the bottom, we are buying "on average" ca. 5.85% lower (12.85%- 7%) than our previous exit price. It is as simple as that.

This is why I always "welcomed" and honored "sell" (primary bear market) signals. The odds of buying at a lower price (let alone, escaping big crashes) are on my favor.

I must thank Jack & Bart Schannep of "thedowtheory.com" for having calculated the exact price level at which "buy" and "sell" signals are given from the respective "tops" and "bottoms". I quote from their latest Newsletter of June 30 (which is a must read as it is packed with valuable insights. It is in my opinion the best financial newsletter by a long shot):

"The record over the last 62 years and 36 signals is that the DowTheory for the 21st Century BUY signals on average start at 7.4% of the lows and the Sells within 7.7% of the tops"

Therefore, while these figures are not carved in stone and are likely to oscillate in the future as future trades keep changing the average, we have a rough measure of what to expect when using Schannep's Dow Theory.

Please mind that these figures apply only to Schanneps' Dow Theory and not to the "Rhea/Classical" one. As readers of this blog know the "classical" Dow Theory due to its using only two indices and needing more time to declare a secondary reaction tends to react slower than Schannep's, and hence the entries and exits tend to be at a greater distance from their respective bottoms and tops. My rough, very rough estimate, lies at around 9-10%. Maybe one day, I'll find the time to make the exact calculations.

Cogitate Schannep's figures in order to convince yourself of the ability of his Dow Theory to detect tops and bottoms.

Sincerely,

The Dow Theorist