Category Archives: Dow Theory

Dow Theory and Richard Russell

Posted on July 11, 2010 by | Comments Off on Dow Theory and Richard Russell

In attempting to understand Dow Theory it is necessary to follow the best and the brightest on this topic. Over the last 52 years, the brightest person on Dow Theory has been Richard Russell. No single person has been more outspoken on their views on the market using Dow Theory, uninterrupted since 1958, than Richard Russell. So when Richard Russell does an about face on his interpretation of Dow Theory it is worth our time to examine the reasons.

First, it is necessary to provide context around the ideas on Russell’s most recent market call.

  • From November 12, 2007 to January 2, 2009, Russell indicated that we were in a bear market. The Dow went from 12,987.55 to 9,034.69, a decline of -30.44%.
  • From January 5, 2009 to January 12, 2009, Russell indicated that we were in a bull market. The Dow went from 8,952.89 to 6,926.49, a decline of –22.63%.
  • From March 11, 2009 to July 22, 2009, Russell indicated that we were in a bear market. The Dow went from 6,930.40 to 8,881.26, a gain of +28.15%.
  • From July 23, 2009 to May 19, 2010, Russell indicated that we were in a bull market. The Dow went from 9,069.29 to 10,444.37, a gain of +15.16%.
  • From May 20, 2010 to July 8, 2010, Russell indicated that we were in a bear market. The Dow went from 10,068.01 to 10,138.99, a slight gain was registered for the period (<1%).

On July 9, 2010, Richard Russell said:

“When the facts change, I change. To do otherwise would be idiotic. Something occurred yesterday that made me sit up and take notice. We had the non-confirmation by the D-J Transportation Average, a situation that I discussed on the July 5 site.”

“Following the Transport non-confirmation, yesterday the market surged higher, Dow up 274 and Transports up 152. But that’s not all. What I noticed was that yesterday was a 90% up day [up volume versus down volume] — the formula for a bottom.”

According to Russell, the Transports non-confirmation along with a 90% up volume/down volume ratio is what led to the conclusion that the market was indicating that a bottom was in. Russell goes on to recommend buying various ETFs with stop losses. Several problems arise when market action is viewed from Russell’s perspective.

First, Russell has ignored the fact that a trend is in place until a counter trend is signaled. So far, we haven’t had a bear market indication since the March 9, 2009 low. If the Transports were to confirm the Industrials by falling below the February 5, 2010 low, then we’d have our first bear market signal.

Second, when thinking in terms of Dow Theory, market participants have three variables to consider the Dow Jones Transportation index, Dow Jones Industrials and NYSE volume. Volume attributes are considered over a period of time. Single day action on volume should not be the determining factor for considering a bull or bear market. If this is the case, then most market signals could be very misleading. In my observations, market volume has increasingly become an addendum to Dow Theory.

Third, Russell has often disregarded the pure Dow Theory indications that have come along the way since the March 2009 low. It seems that Russell’s understanding of macro issues and his personal experience in the markets has led to his decision to err on the side of caution. However, Russell’s cautious streak has usurped the value of Dow Theory to act as a “…composite index of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly discounted in their movement. The averages quickly appraise such calamities as fires and earthquakes.” (Rhea, Robert, The Dow Theory, page 19).

Next, Russell has set himself up for the need to change his analysis by not thinking through Dow Theory to its conclusion. By calling a bottom at this juncture, Russell has left out the all-important confirmation that is required by the Industrials and Transports. 10,450.64 and 4,467.25 are the new levels that the Industrials and Transports need to surpass before any buying policy should be considered. In addition, after surpassing the referenced upside confirmation points, the next level of resistance is 8% away for both indexes. This means that we could go to the old high and then quickly reverse to the downside if a bull market confirmation isn’t signaled. However, given the most recent market action, our focus should be on the confirmation of the reversal pattern first, then the possible bull market indication.

Another matter of concern is that Richard Russell makes recommendations that don’t address the issue of investing in values. Values are a core tenet of Dow Theory. In fact, when you read Dow Theory Unplugged or Charles H. Dow: Economist, you will find that values, not technicals, are espoused. Russell points his readers to speculative opportunities instead of undervalued stocks which can be held for “the long term” if the bullish assessment happens to be incorrect. Our list of Dividend Achiever stocks at or near a new low addresses the prospect that if we’re wrong there is some recourse. In this case, you get the ability to compound your investment over time with the prospect of capital appreciation.

Finally, our stance on stop loss orders is widely known as indicated in the article “Automatic Orders Don’t Provide Protection” as well as our disclaimer at the end of each sell recommendation. Russell’s recommendation of buying ETFs is reckless at best especially in light of the May 6, 2010 “flash crash.” Adding fuel to the flames is the article titled “ETF ‘Circuit Breakers’ Needed to Stop Flash Crashes: Pros.” Our stance on ETFs is well founded and preceded any discussion of the true risks associated with them on May 6th (“ETF: Mediocrity With No Pretense of Value” and “ETF: Indiscriminant Risk”).

It is likely that perma-bulls will seize on the Russell commentary of July 9th as the heralding of a new-new era in investing. On the other hand, “contrarian investors” will suggest that when Richard Russell, perma-bear that he is, has entered the bull ring then the bull run is definitely over. It is our contention that while Richard Russell might be right about a reversal pattern being in place he is not using Dow Theory.

Our latest views on Dow Theory can be found at the following link (NLO on Dow Theory). Keep in mind that all trends are considered to remain in place until otherwise indicated. So far we are still in a cyclical bull market within a secular bear market

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Posted in Dow Theory, Richard Russell, Richard Russell Review

Dow Theory and Richard Russell

Posted on July 11, 2010 by | Leave a comment
In attempting to understand Dow Theory it is necessary to follow the best and the brightest on this topic. Over the last 52 years, the brightest person on Dow Theory has been Richard Russell. No single person has been more outspoken on their views on the market using Dow Theory, uninterrupted since 1958, than Richard Russell. So when Richard Russell does an about face on his interpretation of Dow Theory it is worth our time to examine the reasons.
First, it is necessary to provide context around the ideas on Russell’s most recent market call.
  • From November 12, 2007 to January 2, 2009, Russell indicated that we were in a bear market. The Dow went from 12,987.55 to 9,034.69, a decline of -30.44%.
  • From January 5, 2009 to January 12, 2009, Russell indicated that we were in a bull market. The Dow went from 8,952.89 to 6,926.49, a decline of –22.63%.
  • From March 11, 2009 to July 22, 2009, Russell indicated that we were in a bear market. The Dow went from 6,930.40 to 8,881.26, a gain of +28.15%.
  • From July 23, 2009 to May 19, 2010, Russell indicated that we were in a bull market. The Dow went from 9,069.29 to 10,444.37, a gain of +15.16%.
  • From May 20, 2010 to July 8, 2010, Russell indicated that we were in a bear market. The Dow went from 10,068.01 to 10,138.99, a slight gain was registered for the period (<1%).
On July 9, 2010, Richard Russell said:

 

“When the facts change, I change. To do otherwise would be idiotic. Something occurred yesterday that made me sit up and take notice. We had the non-confirmation by the D-J Transportation Average, a situation that I discussed on the July 5 site.”
“Following the Transport non-confirmation, yesterday the market surged higher, Dow up 274 and Transports up 152. But that's not all. What I noticed was that yesterday was a 90% up day [up volume versus down volume] -- the formula for a bottom.”
According to Russell, the Transports non-confirmation along with a 90% up volume/down volume ratio is what led to the conclusion that the market was indicating that a bottom was in. Russell goes on to recommend buying various ETFs with stop losses. Several problems arise when market action is viewed from Russell’s perspective.
First, Russell has ignored the fact that a trend is in place until a counter trend is signaled. So far, we haven’t had a bear market indication since the March 9, 2009 low. If the Transports were to confirm the Industrials by falling below the February 5, 2010 low, then we’d have our first bear market signal.
Second, when thinking in terms of Dow Theory, market participants have three variables to consider the Dow Jones Transportation index, Dow Jones Industrials and NYSE volume. Volume attributes are considered over a period of time. Single day action on volume should not be the determining factor for considering a bull or bear market. If this is the case, then most market signals could be very misleading. In my observations, market volume has increasingly become an addendum to Dow Theory.
Third, Russell has often disregarded the pure Dow Theory indications that have come along the way since the March 2009 low. It seems that Russell’s understanding of macro issues and his personal experience in the markets has led to his decision to err on the side of caution. However, Russell’s cautious streak has usurped the value of Dow Theory to act as a “…composite index of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly discounted in their movement. The averages quickly appraise such calamities as fires and earthquakes.” (Rhea, Robert, The Dow Theory, page 19).
Next, Russell has set himself up for the need to change his analysis by not thinking through Dow Theory to its conclusion. By calling a bottom at this juncture, Russell has left out the all-important confirmation that is required by the Industrials and Transports. 10,450.64 and 4,467.25 are the new levels that the Industrials and Transports need to surpass before any buying policy should be considered. In addition, after surpassing the referenced upside confirmation points, the next level of resistance is 8% away for both indexes. This means that we could go to the old high and then quickly reverse to the downside if a bull market confirmation isn’t signaled. However, given the most recent market action, our focus should be on the confirmation of the reversal pattern first, then the possible bull market indication.
Another matter of concern is that Richard Russell makes recommendations that don’t address the issue of investing in values. Values are a core tenet of Dow Theory. In fact, when you read Dow Theory Unplugged or Charles H. Dow: Economist, you will find that values, not technicals, are espoused. Russell points his readers to speculative opportunities instead of undervalued stocks which can be held for “the long term” if the bullish assessment happens to be incorrect. Our list of Dividend Achiever stocks at or near a new low addresses the prospect that if we’re wrong there is some recourse. In this case, you get the ability to compound your investment over time with the prospect of capital appreciation.
Finally, our stance on stop loss orders is widely known as indicated in the article “Automatic Orders Don’t Provide Protection” as well as our disclaimer at the end of each sell recommendation. Russell's recommendation of buying ETFs is reckless at best especially in light of the May 6, 2010 “flash crash.” Adding fuel to the flames is the article titled “ETF ‘Circuit Breakers’ Needed to Stop Flash Crashes: Pros.” Our stance on ETFs is well founded and preceded any discussion of the true risks associated with them on May 6th (“ETF: Mediocrity With No Pretense of Value” and “ETF: Indiscriminant Risk”).
It is likely that perma-bulls will seize on the Russell commentary of July 9th as the heralding of a new-new era in investing. On the other hand, “contrarian investors” will suggest that when Richard Russell, perma-bear that he is, has entered the bull ring then the bull run is definitely over. It is our contention that while Richard Russell might be right about a reversal pattern being in place he is not using Dow Theory.
Our latest views on Dow Theory can be found at the following link (NLO on Dow Theory). Keep in mind that all trends are considered to remain in place until otherwise indicated. So far we are still in a cyclical bull market within a secular bear market.

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Richard Russell Review: Letter 742

Posted on July 6, 2010 by | Leave a comment
Dow Theory Letters issue 742 was published on November 1, 1978. At the time, the Dow Jones Industrial Average indicated was at the 806.05 level. In this issue, Richard Russell discusses several topics that are very important to every Dow Theorist.
First, Russell states that:
“…history shows that when bull (or bear) markets really begin, Dow Theory signals are generally greeted with derision, skepticism, and scorn-rather than wholesale agreement!” page 1
This comment is in response to the Dow Theory bull market signal that was given on August 2, 1978. In this case, Russell felt there wasn’t enough skepticism by market participants to warrant a need to trust the signal. I’m guessing that after 12 years of a secular bear market any good news about the market would appeal to the glass half-full crowd.
Letter 742 also has a chart (located here) of the Dow Jones Industrials, Transports, Utility Averages and NYSE volume. Upon closer inspection of the chart below, ranging from March 28, 1978 to October 27, 1978, you can find two confirmations of a bull market and one confirmed bear market indication as part of Dow Theory.

According to Russell, point A (August 2nd), on the Dow Industrials, was a false secondary peak or bull market indication. However, it should be noted that when the Industrials went above the June 29th peak of 821.64 (point A1) on July 21st it was a clear indication that the index was going to retest the previous high at point A.

After the bull market move upward a bear market indication was given when the Industrials and Transports fell below point B1 that corresponded to the August 31st low of 876.82 and 248.78 respectively. A bull market non-confirmation was indicated (red circles) in the fact that neither index could exceed the high of September 8, 1978.
Let’s do the math for a moment, point A1 gave a buy signal plus point A’s confirmation of the buy signal equaled a 9.62% rise by the time the market gave the bull market non-confirmation at Dow Industrials 900. The same timing applied to the Dow Transports would have equaled a gain of 13.64%. To my mind, this was in line with our view that any return close to 10% in less than a year is an acceptable amount to trigger a sell of any stock.
Russell also repeats a common attribute that he seeks in the market before considering going “all in.” Russell says:

“I noted that every bull market in history had started from an over-sold base, but that this market had not seen a over-sold condition since late-1976.” Page 1.

In this remark, I have two thoughts that immediately come to mind which is reflected in the chart below. The first is that even after the 1974 bottom there was another time (1976) that was “most ideal” to buy stocks at over-sold levels, according to Russell. However, even though late-1976 was experiencing oversold conditions, it certainly didn’t mean that further declines were out of the question. After the ’76 bottom, the Dow Industrials had a short rally and then fell as low as 742.12, a decline of 19.69% from the 1976 lows, by February 28, 1978. Finally, the view that an over-sold base is a condition necessary for a bull market may not be accurate.

On page 2 Russell said:

“Right now, I want all my subscribers to stay out as per my instructions in Letter after Letter.”

This suggests that after the January 1975 buy signal given by Russell, it was very difficult to keep a long-term position even though it was the absolute best time to “buy and hold” stocks.

“The violence and rapidity of this smash has few precedents in stock market history.” Page 2.

When calculated to the November 14, 1978 low, the decline from September 8, 1978 equaled a drop of 13.5%. To me this doesn’t seem like all the much of a decline.

“Somewhere in the period ahead, we are going to see the real ‘third phase bear market action’ in the Dow and most other stocks. True, during 1973-1974 the majority of stocks were pulverized in a slide that was comparable to 1929-32 in many ways. But the Dow lost less than 50% of its value at that time. My guess is that before the third or final phase of this bear market is over, we are going to see the Dow at drastic new lows, we’re going to see dividends cut across the board, we’re going to see very high interest rates, and we’re going to see something that this generation has never seen before-wholesale liquidation of debt in all sections of the economy, private, corporate and perhaps even government.” Page 2

“Each time it looks as if the ‘plug is going to be pulled,’ the bear market (with the help of huge infusions of monetary inflation from the Fed) pulls itself out of the hole.” Page 2

Russell was waiting for the third phase of the bear market. According to Russell, the Fed was holding the market up with the trade-off being higher inflation. My thinking is that a crash didn’t occur simply because the Fed was willing to accept higher inflation as a substitute for a crash. In addition, if the markets were to get a crash and record inflation at the same time it would be exceptional situation. The third phase decline that Russell expected never seemed to materialize on the scale of 1973-74 or greater.
Other Notes in Letter 742:
  • E. George Schaefer’s investment performance from 1949 to 1966.
  • James Dines book the “Invisible Crash”
  • MC Horsey’s chart of an inflation adjusted Dow since 1960
  • Benjamin and Herbert Stein’s book “On the Brink” with reference to, of all things, the Chinese cornering the gold market
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Richard Russell Review: Letter 745

Posted on July 4, 2010 by | 1 comment
Dow Theory Letters Issue 745 was written on December 6, 1978.  At the time, the Dow Jones Industrial Average was indicated to be at the 811.42 level.  What stood out the most to me was the fact that Richard Russell made very clear commentary on the price of gold and the direction of stocks.  Russell made the following commentary:

"It [gold/stock ratio] is telling us that for the foreseeable future (until the next signal), if we do anything we should do it in stocks." page 3.

Anyone familiar with the stock market in 1978 would know that if you had bought a handful of stocks and didn't sell them until 10 years later you would have had a compounded annual growth rate of 8.73% (this takes into consideration the crash of 1987).  Russell's comments on being in stocks would have seemed to be very much on target.  However, it is his aversion to gold at this time that seems to contradict his earlier comments on gold.
In Letter 742 dated November 1, 1978, Richard Russell said the following about gold:
"Slowly, very slowly, it's dawning on the world that we're witnessing one hell of a bull market-in gold. I've been writing pages and pages about gold in each Letter, trying to get new subscribers in the metal (or the coins), trying to get older subscribers to STAY in gold.  Happily, a large percentage of my subscribers are now sitting with large gold positions.  And the paper profits (in terms of dollars) are mounting." page 5.

This commentary seems odd because in Letter 745, Russell goes on to say:

"At any rate, it is a bearish omen when the [gold] open interest stays high in the face of a persistent decline, and that is what has occurred." page 6

Russell called himself to task by asking the following question:

"Question: Russell, you were so hot on gold a few months ago.  Gold was 'real money,' you said.  Gold 'would save the system,' you said.  How can you just "turn off" on gold?
"Answer: I haven't turned off on gold, I've turned off on gold at this time.  The market isn't like your wife or your daughter who you love through thick and thin.  We're dealing here with correct procedure and purchasing power.  The fact that I advocate gold-backed currency has nothing to do with the fact that I think gold is in a bear trend over the coming months.  In this business, you had better learn that the trend makes you the money, not the item.  I'd rather buy Cesspools, Inc. if that stock was going up than IBM if IBM is heading down." Page 7
In retrospect, we know that gold went as high as $850 an ounce in January 1980.  However, it is interesting to me that Russell said that a bear trend was approaching "...over the coming months."  In Letter 745, Russell included a chart that compared the London Gold to the Gold Stock Average.

 

Russell's favorable comments of gold on November 1, 1978 were well off of the highs from the prior month.  However, since Russell was a practioner of Dow Theory and was using the London price of gold along with the equivalent of the XAU gold index to act as a confirming mechanism for the future price of gold, it should have been considered that because the London price didn't fall to the corresponding low set in April of 1978 that there must have been a non-confirmation of the downside trend.  Instead, Russell said the following:
"The GSA [Gold Stock Average] has collapsed, and is now down to its previous low for the year recorded last April.  Bullion has obviously held up better than the gold shares, but so far the downside non-confirmations by bullion have failed to halt the decline.  This kind of action is always indicative of a weak market, and it just seems that there are still too many optimistic gold-holders around." Page 6.
Is it possible that the gold shares are held by the public and speculators (weak hands) and the bullion is held by investors and "institutions" (strong hands)?    Somehow I think this relationship has some value.  I'm just not sure if Russell called this intermediate move correctly.  So I decided to search for an updated version of the London Gold and GSA comparison.  Below is what I found in the July 5, 1979 issue:

 

It should be noted that the exact bottom in the price of gold and gold stocks (red circles) coincided with the publishing of the December 6, 1978 Letter 745.
Also Worth Mentioning:
  • Russell said that "Greed and options don't mix."  My impression on this remark is that I always thought that the purpose of options is to get exaggerated gains with the trade-off being no equity.  Seems to me that greed and options go hand in hand.
  • Dow Theory Letters are available at http://www.dowtheoryletters.com/
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Dow Theory

Posted on June 29, 2010 by | Leave a comment
The markets are getting very close to giving us the Dow Theory indication that we need to exit a majority of our positions. Today (June 29, 2010), the Dow Jones Industrial Average closed at 9870.29 which is 53.80 points above the June 7, 2010 of 9816.49. Falling below 9816.49 would be one half of the bear market signal needed to indicate that the market will fall precipitously.

To make matters worse, the Dow Jones Transportation Index closed down today nearly twice as much as the Industrial Index. This indicates that there is significant selling interest. This doesn’t bode well for the Transports because in order to trigger the second half of the bear market signal the index would only have to fall 248.61 points. After today’s decline of 169.52 points in a single day, the remaining 79.09 points needed would not be all that difficult to come by.
The chart below displays a critical reason why I would be bearish on the market at this time. The dashed black line extending from B1 was supposed to be the upside target from point C1 in our last Dow Theory article. However, neither the Industrials nor the Transports were able to come close enough to be misinterpreted as an indication that the bull market run was likely to continue. The inability of the market to breach point B1 was a major non-confirmation according to Dow Theory.
Finally, any simultaneous declines of the Industrials and Transports below the yellow zones on a closing basis would tell us for certain that the bull market has run its course and that an additional correction of 15% on the Dow Jones Industrial Average is likely.

We’re being generous by not considering the June 7th lows for both indexes as the critical points for a bear market indication. For some Dow Theorists, waiting for the Transports low on February 5th is akin to playing with fire. However, we must adhere to the extremes to ensure quality buy and sell signals.

The only holdout is that either the Transportation Index or the Industrial Index gives us a downside non-confirmation by not going below the Feb. 5th or the June 7th lows, respectively. If we get a downside non-confirmation then we will consider selling a small portion of the portfolio on any strength.

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Dow Theory

Posted on May 13, 2010 by | Leave a comment
The decline from the intermediate high on May 12, 2010 is now putting in place the prospects for another classic secondary reaction of the Dow Industrials. According to Dow Theory, secondary reactions can range from 33% to 66% of the move upward from the previous low in the last secondary reaction.

In the chart below, you can see that the last secondary low took place at point C on February 5, 2010.

Depending on the point you choose (using the closing price or the intraday low), the Dow reached a low at 9822.83 on February 5th. From the low, the peak in the Dow occurred on April 26th at the intraday high of 11,308.95. Based on the difference of the low and the high, the next potential downside targets are as follows:
  • 10,565.89
  • 10,318.21
  • 9822.83
According to Charles H. Dow, analysis of market action needs to take in any periods that have similar characteristics. In this case, I believe that the Dow is tracing out exactly the same pattern as had happened from January 19th to February 5th. In the points A1, B1, and C1 we can see the pattern that might materialize according to Dow’s theory.
So far, we have already traced out the pattern from A1 to B1. The turn at B1 has laid the groundwork for what we can expect might happen next. The prospect is that we fall below 10,375 and possibly turn upward somewhere around 10,200. However, because of the extreme decline that occurred on May 6th, the Dow could fall as low as point C and still reverse back to the point B1.
If the Dow falls below the blue line at point C, then we can label the market trend as bearish. In addition, all of the moves in the Dow Industrials must be confirmed by the Transportation index. The ideal scenario is that the index goes back to B1 at the very least. However, with all the recent turmoil in the markets, I would not be surprised if we got a bear market signal below point Z.
It should be noted that although I have only discussed a bunch of lines going up and down, the ideas behind the concepts are rooted in fundamentals. The very same fundamentals that formed the basis for investors like Graham, Dodd and Buffett.

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Dow Theory Q & A

Posted on April 13, 2010 by | Leave a comment
Reader SD asks:
 
"If the Dow appears to hit a peak and begins dropping (Dow Theory bear market indication), is the indicated action to sell your stocks and put your investments into cash until the Coppock curve or other indicators show the market has hit a bottom?"
 
Touc's Reply:
 
There are several approaches to the use of Dow Theory when determining the best time to sell stocks. The first could be to sell all stocks when a Dow Theory bear market is signaled. The second could be to ignore the gyrations of the market and only sell a stock when it is "clearly" overvalued. The final method is the one that I use which involves changing my allocation of stocks.
 
In the first scenario, we will take the perspective of the great Dow Theorists Richard Russell on the application of Dow Theory towards the portfolio when a bear market is signaled. Upon reflection of the market declines from October 2007 to March 2009, Richard Russell said, "...Let's say you are compounding your assets (reinvesting your dividends and interest) beautifully until a full-fledged primary bear market comes along (1973-74 and again in 2008). Within a year or two your assets are cut in half, and all your compounding has gone to waste." By this commentary, Russell seems to imply that an investor should sell all of their stocks at the onset of a Dow Theory bear market indication or risk wiping out tremendous gains that might have been accrued in the process.
 
On November 12, 2007 Richard Russell call the bear market top in the weekly financial publication Barron's. According to Russell, it makes no sense to trifle with the bear market which can plumb depths unimaginable in a period of time that is far shorter than it takes to rise in a bull market. So why risk wasting the power of compounding to a bear market, especially when you "know" it is coming. In this respect, Russell says sell all of your stocks and wait until the next bull market indication to arrive.
 
The second Dow Theory approach to selling a stock is the most commonly misapplied. This approach is supposed to be grounded on the belief that market participants understand values. The misapplication that often occurs is when overvaluation is ignored and a stock isn't sold based on this fact. All Dow Theorists can point to the buying and selling of stocks as being based in the understanding of values. The claim of an understanding of values applies to stocks that are undervalued as well as overvalued. An undervalued stock should be bought while an overvalued stock should be sold, regardless of market condition. Once an undervalued stock has been purchased it could take weeks, months, or years before the stock is overvalued. A stock that has become overvalued should be sold at the earliest opportunity and is often at a new high.
 
In answer to the question of when to sell a stock based on values, the renowned Dow Theorist Robert Rhea had the following to say:
 

"Investors may ask how they can determine the point when stocks are selling far above value and probable earnings. That, indeed, is a hard question to answer because no two men appraise values on the same basis. I can only say that sometime before the peak was reached in 1929, American Telephone and Telegraph [AT&T] (T) was selling around $300 per share. It had a book value of about $128, and its best recorded earnings were in 1929 when the reported net for common was $12.67 per share. Now in 1926 the stock had sold for $151 when its book value was $126, with earnings of $11.95. With its dividend at $9.00, a comparatively small amount was carried to surplus each year. At the price first noted above, the advance in the quoted value of this stock had obviously discounted earnings for many years in the future; moreover, it was selling far above its intrinsic value."

The last method for buying and selling is one that I have combined and modified based on the methods described above which involves taking the Dow Theory signal and allocating more or less money to a given stock. During periods when there is a Dow Theory bull market indication, I invest a minimum of 25% of my capital in a single stock that is at or near a new low. After obtaining what I believe to be "fair profits," I rotate the money into the next "undervalued" Dividend Achiever or Nasdaq 100 stocks. As long as the bull market indication is in effect, I continue to overweight my stock positions in solid companies with proven track records. I'm very flexible in the amount of time that it takes to accomplish the goal of exceeding "guaranteed" money alternatives like treasuries, CDs, money market and savings accounts on an annualized basis.
 
As soon as a bear market signal is given, based on Dow Theory, I shorten the amount of time that I'm willing to wait for an undervalued stock to generate "fair profits." In addition, I cut my minimum position in an individual stock down from 25% to 12% (generally speaking). Basically, I reduce the amount of risk that I'm willing to take in a stock under conditions that might not be as favorable for gains. However, I do not sell stocks outright in anticipation of market declines based on Dow Theory bear market indications. Keep in mind that, under certain circumstances, a bull market can still be in effect after a decline of 20% to 30%. This leaves a lot of room for miscalculation if you automatically sell based on a decline of 10% or more.A review of my 2008 and 2009 transaction histories should demonstrate the value of the approach described above. Follow-up commentary regarding the 2008 transaction history is worth reading as it provides additional insight to the methods now used by the New Low Observer team. It is important to note that, although there was a bear market indication since November 2007, activity in the market did not cease.
 
Again, keep in mind that bear markets are no guarantee of losses in your portfolio. Charles H. Dow, founder of the Wall Street Journal, has said that:
 

"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."

I feel that the strategy that we employ is very close to what Charles H. Dow had written about in regards to buying and selling stocks in both bull and bear markets.
 
Art's Reply:
 
Even when a bull market indication is given or the Coppock Curve turned positive, we have to be rational about deploying our capital. A Dow Theory buy indication doesn't signal "all-in" or imply that we can buy stocks blindly. Some stocks performed wonderfully and some lag the market. The same can be said about bear markets.
 
Touc and I bought Altria (MO) in early December 2008 when the company yielded 8%. This transaction occurred during the bear market and took place months before the market reached a bottom. Our sell recommendation netted 13% in less than 2 months.
 
If you'd like to prepare yourself for the coming bear market, I suggest that you pick up a book by Harry Schultz, Bear Market Investing Strategies.
 
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Dow Theory

Posted on April 11, 2010 by | 2 comments
On Friday April 9, 2010, the Dow Jones Industrials and the Dow Jones Transportation Averages both moved to new highs at the same time. According to Dow Theory, this confirmation by both averages would indicate that the market has more room to go on the upside before a change of direction is to take place.
The path to this bull market confirmation (within a secular bear market) has been a battle with many casualties. The last week had many examples to demonstrate this point. On April 5th, the Industrials broke to a new closing high however the Transports did not confirm. On April 6th, the Transports broke to a new high but the Industrials did not confirm. On April 8th, the Transports broke above the high that was established on April 6th however the Industrials could not exceed the previous high of 10,973.55 set on April 5th.  April 9th finally cleared the air on the much needed confirmation of the market's trend.
The factors that are in favor of the continuation of the bull market are that the Industrials and Transports are 50% above their respective 2007 to 2009 declines. Additionally, prior declines within secular bear markets like 1906 to 1924 or 1966 to 1982 have had many retrenchments of 80% to 100% before falling back to the old lows. So far, the Industrials have recouped 58.42% of the previous decline. If the Industrials were to retrace a classic Dow Theory 2/3 of the previous decline, the index could go to 11,574.59 with no problem.
However, the tepid nature of the gains that led to the new highs along with the lackluster volume that has accompanied the move up from the March 9, 2009 low doesn’t seem to encourage confidence in the direction. More alarming is the fact that we are not near historical levels of under-valuation in the market in general. The Dow Industrials currently has a dividend yield of 2.48% when the long-term average high yield is around 6%. Also of concern is that the Dow Fair Value is at 6.92 times the dividend yield. This is contrasted with the 1.52x that is normally associated with great buying opportunities.
The former editor of the Wall Street Journal and Dow Theorist William Peter Hamilton once said, “the wish must never be allowed to father the thought.” For this reason, we will take a wait and see approach to the market going forward.  However, until proven otherwise, we are on a march back to Dow 14,164.53, which was set on October 9, 2007. In anticipation of the rise to the old market high, we have illustrated, in the chart below, three upside scenarios for the Dow Industrials.
The first projection (green line) assumes that the Industrials will continue the torrid pace set from March 9, 2009 to January 19, 2010. The likelihood of the index continuing at such a pace is not expected. However, in the book Charles H. Dow: Economist by George W. Bishop, Jr., it is noted that, according to Charles Dow, there are two stages to a bull market in stocks and that the second stage is more bullish than the first stage. This contrasts sharply with Robert Rhea and William Peter Hamilton’s assertion that there are three stages to every bull and bear market. If we are in the transition to the “second and final” stage of this bull run then it is possible for the market to continue on, and possibly exceed, the first trajectory that was previously set. The projected date that the Dow would reach 14,164.53 is November 19, 2010.
The second projection (blue line) is based on the March 9, 2009 to April 9, 2010 action on the Dow Jones Industrials. This pace seems more realistic than the first projection since it assumes a less dramatic increase in the index. To think that the market could continue moving higher as it had in the past would be quite unrealistic. Based on the current trajectory the Dow would reach the old high by January 31, 2011.
Finally, the third projection (black line) is based on the current trend being the mean and the first projection being the high end of the range. The third projection is a mirror of the first. The third trajectory would reach the old high by June 18, 2011.
Although we have a clear bull market confirmation (within the context of a secular bear market) it is necessary to determine where the downside targets should be. According to Dow’s Theory the following are the targets for a subsequent decline:
  • 9513.92
  • 8030.49

In addition to the normal downside targets, there is the prospect that if the Dow falls below the imaginary third projection level (black line), then all bets are off.  From the current Dow Theory confirmation, if the index cannot retains the level of 10,997.53 beyond July 15, 2010, then the market should have a major correction shortly thereafter.
Reaching the old high is all within the context of a normal secular bear market. The tendency is for the market to get to the old high and then quickly wipe out the notion that a new secular bull market is about to begin. This is the nature of a secular bear market.
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Dow Theory

Posted on March 23, 2010 by | Leave a comment
On October 16, 2009, I wrote an article on SeekingAlpha.com titled “Stock Market Projections,” where I attempted to predict the next low point for the Dow Industrials. In that article I said:
“After I ran the numbers, the cycle analysis method indicates that from January 24, 2010 to February 15, 2010 is the next expected low.”
Eerily, the Dow Jones Industrial Average has managed to hit a major low on February 8, 2010. This is almost exactly in the middle of the range where, based on cycle analysis, the Industrials were expected to go. At the time it was my assertion that after hitting the low in February 2010 we could expect that the next move upwards would be to the 12,000 level.
The case for the move upward has been bolstered by the fact that, according to Dow Theory, the Industrials and the Transports have exceeded their January 2010 highs based on the closing price of March 18, 2010. However, as the Industrials have exceeded their March 18th closing price the Transports have not followed through so far.  This type of divergence between the two indexes is generally considered to be a non-confirmation.
The great Dow Theorist Richard Russell (Dow Theory Letters) has spoken at length about non-confirmations in the indexes and how to interpret the trend of the market in this context. According to Russell:
"It is a reasonable practice in areas of non-confirmation or divergence to give precedence to the primary direction. Thus, after a rally in a bear market, when one Average refuses to confirm the other on the upside, the strong presumption is that the next direction of the market will be down. More positive proof is provided if the two Averages then retreat below previous minor decline lows. The converse of this is true in a bull market, and many impressive advances have been “tipped-off” in areas where one Average refused to follow (confirm) the other through an important low point."
Richard Russell, Dow Theory Letters, Issue 102, May 2, 1960, page 2. www.dowtheoryletters.com
We would not be totally satisfied with the bull market indication (within a secular bear market) until the Transportation Index is able to go above 4422.50. However, until that time, we would consider this a bull market that is waiting for a confirmation rather than a potential bear market in the making. While we’re still sticking to a projected Dow Industrials of 12,000, the market has seemed to run out of the explosive bursts on the upside that it once had. Despite this concern, we wouldn’t be surprised of the market truly melted up from the current level.
  • The article on Seeking Alpha titled “Stock Market Projections” is here.
  • For better viewing, the chart in the article is here. 

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Dow Theory Q & A

Posted on February 23, 2010 by | Comments Off on Dow Theory Q & A
A reader writes:
 
"Without the Obama stimulus and intervention from the FED it would already be below 5000. The existing position is totally artificial, unsustainable and downright ephemeral. Any one that claims that this synthetic bull market is sustainable is full of it.
 
"It is interesting to note how much you can derive from the historical shape of a line with zero analysis of why it was that shape. You have not even quoted a single example of a similar pattern resulting in a similar outcome to your predictions. In other words, this is not a scientific approach. It not even a logical approach. I can only conclude that the sole purpose of such analysis is to influence the market in a desired direction. In other words it is a propaganda approach."
 
Our Response:
 
Manipulation is a factor of the market in the day-to-day movement. However, the long-term trend of the market cannot be manipulated as demonstrated from the writings of William Peter Hamilton, former editor of the Wall Street Journal.
 
Using Dow Theory, Hamilton called the top in the stock market on October 25, 1929 in a WSJ editorial titled “A Turn in the Tide.” It should be noted that the comments on manipulation made by William Peter Hamilton were done when it was well known who and when manipulation took place prior to the institution of the SEC.
 
In his book The Stock Market Barometer, Hamilton outlines many methods of manipulations as they took place and its relevance to the overall market. In his book, Hamilton says of manipulation:
 
  • “The market is always under more or less manipulation.” page 37.
  • “Even with manipulation, embracing not one but several leading stocks, the market is saying the same thing, and is bigger than the manipulation” page 42.
  • “Major Movements Are Unmanipulated-One of the greatest of misconceptions, that which has militated most against the usefulness of the stock market barometer, is the belief that manipulation can falsify stock market movements otherwise authoritative and instructive” page 49.
  • “These discussions [of manipulation] have been made in vain if they have failed to show that all the primary bull markets and every primary bear market have been vindicated, in the course of their development and before their close, by the facts of general business, however much over speculation or over-liquidation may have tended to excess, as they always do, in the last stage of the primary swing” page 50.
  • “It has been shown that, for all practical purposes, manipulation has, and can have, no real effect in the main or primary movement of the stock market, as reflected in the averages. In a primary bull or bear market the actuating forces are above and beyond manipulation. But in the other movements of Dow's theory, a secondary reaction in a bull market or the corresponding secondary rally in a bear market, or in the third movement (the daily fluctuation) which goes on all the time, there is room for manipulation, but only in individual stocks, or in small groups, with a well-recognized leading issue” page 73.
Hamilton, William Peter, The Stock Market Barometer, Wiley & Sons, New York, 1922.
Another great Dow Theorist, Richard Russell, editor of the Dow Theory Letter which has been published consistently since 1958, called the market bottom in October 1974 and called the top in November 2007 (read Barron's article here). The extensive history of reasonably accurate and well-documented calls of market direction make examining Dow Theory worthwhile. The purpose of showing Russell’s remarks on the topic of manipulation is to demonstrate that, although there is a distinct difference between the pre-1934 SEC market of Hamilton era and today, the rules, according to Dow Theory, remain the same.
 
In The Dow Theory Letters, Richard Russell reiterates the fact that:
 
“One of the most difficult concepts to get across to subscribers is the concept of primary trend of the market. This may be old hat to my veteran subscribers of 10 or 20 years, but the whole idea of the primary trend bears repeating now.
 
“There are three trends in the market, all working with each other simultaneously. There is the great primary trend, lasting usually a few years up to 15 years or even longer. There is the secondary trend lasting usually a few months up to a year. And there is the minor or daily trend lasting a few days to a few weeks or so.
 
“The minor trend of the market is open to manipulation. This shortest of trends may reflect a news event, a sudden scare, a sunny word from the president or any of a thousand other possibilities.
 
“The secondary trend often reflects a short-lived expansion or recession that the economy or some very major news event. The secondary trend is also open to manipulation, usually on the part of the Fed in that the Fed can make money tight or loose (the Fed can even bring on a recession by restricting credit or the Fed can see a boom by opening the money spigots wide).
 
“The primary trend is the great tidal trend of the market. When the tide is coming in we term it a bull market. When it is going out we call it a bear market. One of the basic tenets of Dow theory is that the primary trend of the market cannot be manipulated. That’s a point that every investor must understand. The primary trend is more powerful than the power of the Federal Reserve, Congress, and the president combined. When the primary trend of the market turns down (as it did early 1973) stocks will decline until the market discounts the worst that can be seen ahead. When the primary trend turns up (as they did in late 1974) the market will rise until the best that can be seen ahead is fully discounted in the price structure.
 
“But the point I want to get across to subscribers is that once the direction of the primary trend is set, the market will fully express itself in the primary direction. The primary trend may be held back for a while, secondary reactions may interrupt the primary trend, but ultimately the trend will run to conclusion, it will express itself fully.”
 
Russell, Richard, Dow Theory Letters, January 24, 1990, Letter 1035, 2
Keep in mind that Dow theory isn’t a cure all for investment success. As aptly stated by yet another great Dow Theorist Robert Rhea in his book “The Dow Theory," he states:
 
“The Dow theory is not an infallible system for beating the market. Its successful use as an aid in speculation requires serious study, and the summing up of evidence must be impartial. The wish must never be allowed to father the thought.”
 
Rhea, Robert, The Dow Theory, 1932, Barron’s Publishing, 26
Rhea is known for having called the market bottom in 1932 with the publishing of the book The Dow Theory as well as in his newsletter Dow Theory Comment. Despite the clarity in the fact that Dow Theory is not “infallible” the point is made that the use of Dow Theory has the significant value of synthesizing all current and foreseeable economic, political, and social information. Rhea quotes Hamilton with the following thoughts:
 
“The Averages Discount Everything -- The fluctuations of the daily closing prices of the Dow-Jones rail and industrial averages afford a composite of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly anticipated in their movements.”
 
Rhea, Robert, The Dow Theory, 1932, Barron’s Publishing, 19
For the fact that Dow Theory is supposed to include all information, there is little reason for me to speculate on the reasons why and how the market will do what I interpret the averages to be saying. Furthermore, the idea that Dow theory is about a bunch of lines is an unfair assessment at best. Suffice to say, Dow Theory is founded primarily on values then market sentiment and finally explained in a technical fashion (using lines.) Those wishing to understand the value component of the theory can find it throughout the New Low Observer website. However, keep reading for more insight on how value plays a role in your investment strategy.

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Dow Theory

Posted on February 22, 2010 by | Comments Off on Dow Theory
Although the markets have been relatively quiet in the last few weeks, according to Dow Theory, the Dow Jones Industrials Average and the Dow Jones Transports Average have been demonstrating classic conditions that would allow us to determine if the market will continue beyond the prior highs set in January or continue lower.
The Dow Jones Industrial Average is the measure by which everyone gauges “the market.” In the chart below, since the January 19th peak of the Industrials, the market declined until the February 8th bottom. After February 8th, the Industrials managed to exceed the rally high of 10,296.84. By exceeding the high of 10,296.84 and the 50% level of 10,368.83, the Industrials have demonstrated a bias towards going higher rather than lower.
For the Dow Jones Transportation Average, the peak of January 11th and the trough of February 8th gave us a decline of 469.97 points or 11.02%. When the index bottomed on February 8th, it was able to exceed the 3993.12 level, which is a classic Dow Theory indication that the index is going back to the old high of 4262.85. Ideally, in the chart below, if the index could stay above the 50% level (red horizontal line) and finally the 3993.12 (blue horizontal line) then we could expect the Transports to go back to the old high and possibly beyond 4262.85.
In order for Dow Theory to work, we need both the Industrials and the Transports to confirm the action of each other. So far, we’ve seen the Industrials confirm the decline started by the Transports on January 11th with a declining pattern on January 19th. After both indexes started trending downwards they both had significant rallies within the downward trend, which peaked at 10,296.84 and 3993.12. Both indexes bottomed on February 8th and moved above the rallying peaks and the 50% ranges within the previous downward trends. All of these confirming moves point to the prospect of a higher market.
The only holdout is that the Industrials went lower today (Feb. 22nd) while the Transports continued higher. From my experience, since the bottom in March 2009, I have noted that the Transports have led the way with the Industrials ultimately confirming the direction. However, this current move down, by the Industrials, while the Transports moved higher has to be taken into consideration. Any non-confirmation could lead to a major change in the trend.
The Industrials now need to stay above either the 10,368.83 or 10,296.84 while at the same time going above 10,402.34 in order to confirm the Transports’ move higher today. Alternatively, if the Industrials break down from here, falling below the 50% and rally peaks, then the Transports should follow in a similar fashion.
It should be noted that the current market action is dancing around my calculations of 10,302 being the 50% level for the Dow Industrials peak of October 2007 and the trough of March 2009 as indicated in my May 2009 posting. It is not surprising that we’re witnessing listless market action at this time. Market participants large and small are deciding if they should capitulate to the trends since March 9, 2009 or get out at a theoretical break-even point. Remember, the 50% level of the previous decline is an approximation of the average price paid by a majority of the current market participants. Is there enough momentum to keep the market going higher? Since March 9, 2009 the Transports have told us the answer to this question. We’ll have to see if this continues to be the case going forward.
-Touc

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Posted in Dow Theory, Dow Theory Confirmation, Dow Theory Non confirmation

Article Commentary and Reply

Posted on February 8, 2010 by | Comments Off on Article Commentary and Reply

The following is a response by a reader regarding the February 8, 2010 article outlining all of the transactions from 2008:

Reader Comment:

I am assuming that by "portfolio" is meant all investable funds among all asset classes like stocks, bonds, commodities, etc.

1) You had 94% of all investable funds in Wesco at one time which to me appears extreme concentration in one asset class, regardless of how confident one is about the prospects. And since the future is unpredictable, I believe the risk/reward outcome unnecessarily becomes a hostage to the "Black Swan" events.

I do note that you had a timely and efficient loss control mechanism in place and that you sold out at a minimal loss. But that might be because you had such a huge overweight in that one stock, forcing you to watch it like a hawk. Had it been a small weight, you might have acted differently, even not having sold out and thus made a much greater profit in absolute terms since Wesco climbed 10% to 15% higher soon after you sold it.

This is a good example of why single, huge overweight concentration in one security is generally counterproductive because we are forced into taking quick actions based on short term volatility and transient perceptions of risk.

2) Almost ten times out of a total of 40 trades you let your realized losses exceed 10% and in one case even go as high as 46%. I am not averse to enduring high unrealized losses in special cases wherein we are convinced about the intrinsic value of the investment, and are willing to "ride out the storm". This is a part of the process of investing. However, I wonder what intrinsic value, or a miraculous turnaround, you were seeing holding Fannie May during the summer and early fall of 2008. Granted, you had a small allocation to this name at the time, but the expectations surrounding this trade appear to me to be speculative in nature.

3) After September every trade was a losing trade (except the three with small profits), all the way through the end of the year. And that was not in the least unusual, since being in the stock market was simply not the right strategy at the time. I am not sure what the Dow Theory was telling us around this time -- during this period of extreme volatility and spreading risks throughout the investment landscape globally. Maybe you can throw some light with respect to the Dow Theory in this context, for this period. And also whether any other asset allocations were considered and rejected. (For instance, 4Q08 provided bountiful profits in the Treasury bonds with minimal volatility and low risk.)

Touc's Reply:

Yes, by portfolio I mean all investable funds that are transacted through a brokerage firm. The percentages given are specific to any and all cash holdings in all brokerage accounts. As part of a truly diversified portfolio, I hold physical gold and silver, real estate and a minority ownership in a restaurant.
Your points about extreme concentration are quite valid, on the surface. However, as you’ll note in my article “Diversification Doesn’t Matter,” the general declines of the market are going to take out an investor no matter how diversified. In fact, the more diversified the account within the realm of stocks, the more likely diminished returns will occur.
Regarding the issue of “black swan” events, as a student of stock market crashes and panics, I have built in the prospect of a “black swan” in every transaction. First, I assume that I will lose at least 50% of my investment before entering into an investment. Second, I accept the reality of the situation based on such thinking. Third, by having an undiversified portfolio, I can clearly address scenarios that exceed losses of 50% or more without a deleterious impact on my mental faculties. With this in mind, I can better determine the risks that I’m about to take.
The matter of Wesco Financial (WSC) is an interesting one to point out. There are at least a couple thoughts, which I will try to elucidate upon. First and foremost is the transaction that preceded the WSC trade. In less than 2 months I was able to advance 96% of my portfolio by 10% with Family Dollar Stores (FDO). All that mattered to me was to not wipe out the gain immediately after accomplishing such a feat. As pointed out, I probably would have acted differently had the position been smaller. The tendency of most diversified (smaller postions) investors is to watch calmly as their entire portfolio declines until the market or stock cannot fall any further, at which point the investor panics and sells at the bottom.
The next issue of concern regarding the Wesco (WSC) trade is the missed gains that followed after selling the stock. This is something that is most pronounced with the entire sell recommendations that I have given on both Dividend Inc. and New Low Observer. In my opinion, investors face two types of greed, one for profit and one for loss. Under the conditions of both forms of greed, only losses can become permanent. I seek to mitigate both extremes of greed for what I am ultimately able to keep. I am unanimous (wink) in declaring that I seek mediocre returns or “fair profits.” In some respects, my willingness to accept missed gains and 50% losses keeps me righted. The fact that my returns have exceeded the downward spiral of 2008 with positive gains is only icing on the cake.
To be honest, I never felt the strain of getting in or out of a stock quickly enough. There never was a sense of being rushed. No wondering in the middle of the night what is going to happen to my outsized trade? After all, either I’m right or I am wrong and the markets will tell me soon enough. For this reason, I was never overwhelmed by the sense that somehow I missed an opportunity. I kept my eye on all the current and former Dividend Achievers and stuck to my core competency.
Fannie Mae (FNM) wasn’t a situation of whether the company had any intrinsic value or not. I simply speculated that the government assurance would bolster the share price of FNM. I was completely wrong about the FNM speculation. However, I ensured that the losses didn’t exceed the gains from the (AIG) speculation that occurred on 2/28/2008, 9/23/2008 with 82% and 38% respectively. Also, I didn’t want to wipe out the Bear Stearns (BSC) speculation of March 14, 2008 with 26% of the portfolio. Another matter of concern is the fact that by September 29, 2008, I had amassed gains of 41% in the same portfolio. I knew I was “playing” with house money. FNM just happened to be one (of many) that didn’t go my way.
The question of my take on Dow Theory in the last quarter of 2008 is very clear. In a Dividend Inc. article titled “A Key Point for the Market” dated October 6, 2008, I stated the following*:
“Today the Dow Jones Industrial Average has fallen to the minimum of 9525.32. This exceeds the Dow Theory projection of 9531.11 posted on this blog on September 17, 2008. Nothing that has happened thus far is surprising according to Dow's Theory. It becomes academic at this point to suggest that we are either going to the 7197.60 level…”
On September 17, 2008, in an article titled “Dow Theory on the Dow Industrials,” I stated the following*:
“After today's stock market action the Dow Jones Industrial Average closed at the level of 10,609.66. This is below the 50% Principal as devised by E. George Schaefer. The 50% principal indicates that if a stock or index falls below this level it will fall, at minimum to the 2/3 level of Dow's Theory. Right now the 2/3 level for the Dow Jones Industrial Average is 9531.11. If the Dow falls below the 2/3 level the next stop will be 7,197.60.”
Although Dow Theory had given a bear market signal, as indicated by Richard Russell’s November 2007 Barron’s article, I stuck to my core competency which is current and former Dividend Achievers with some speculation in gold and silver stocks. Dow Theory, for me, has acted as a guidepost for the market’s general direction, which affects the concentration of each individual stock. However, if Dow Theory were interpreted as Charles Dow has indicated (an approach which I reiterate throughout the site), investors would do well to heed Dow’s remark that “even in a bear market, this method of trading will usually be found safe…”
Thank you for your sincere interest and the opportunity to discuss, at length, the ideas that went into some of my trades during 2008.
-Touc
*anyone interested in the articles dated September 17, 2008 or October 6, 2008 can send an email to me. Those who regularly received the RSS feed or automatic updates should look under the respective dates that the feeds or emails went out from Dividend Inc. I hope you still have those articles.

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Posted in Black Swan, Charles Dow, Dow Theory, Richard Russell, Transaction Review

Dow Theory

Posted on January 24, 2010 by | Comments Off on Dow Theory
According to Dow Theory the following are the downside targets for the Dow Industrials:
  • 9,324.82 (33% retracement)
  • 8,603.64 (50%)
  • 7,882.44 (66%)
  • 6,440.06 (100%)
The downside targets for the Dow Tranports are:
  • 3,576.92 (33% retracement)
  • 3,213.19 (50%)
  • 2,849.45 (66%)
  • 2,121.98 (100%)
Dow Theory indicates that a retracement of 33% to 66% is consistent with a "normal" correction of the previous upside action. Falling below the 50% retracement would be a market decline with a negative bias while staying above the 50% level would be a positive bias for the market overall.
Dow Theory would work fine if it wasn't for the real world interjecting facts and data from time to time. One issue that is of paramount concern is if the Dow Jones Transportation Index falls below the low set on November 2, 2009. As you look at the chart below, you can see that the Transports have traced out a pattern of lower lows that started on October 2, 2009. If we get much lower than 3,350 on the Transports we could consider this an unofficial, cyclical bear market.

Now that the markets have turned we have a solid perspective to work from. Now may be the time to run the numbers on the companies on our watch lists so that you're ready for when the market makes either a turn to the upside or gives the next bull market indication. -Touc

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Dow Theory

Posted on January 10, 2010 by | Leave a comment
There are three areas that I would like to cover regarding Dow Theory. First I’d like to discuss the Dow Theory confirmation of the trend. Next, I want to cover the concept of a “line” and it’s potential impact on the Dow Industrials. Finally, I’d like to discuss the Dow theory 50% rule. Additionally, I want to describe what I believe are the future projections for the market going forward.

On January 8, 2010, the Dow Industrials and the Dow Transports confirmed the Dow theory cyclical bull market trend of the stock market. The significance of this is that we can expect the Dow Industrials to head much higher in spite of the threat of future economic uncertainties. Below are the recent charts for the Dow Transports and the Dow Industrials.

Since November 9, 2009, the Dow Industrials have traded in a tight range of less than 3%. According to Dow theory, the market trading in a range of about 5% is considered to be a “line.” A line is a key indication of accumulation or distribution of stocks. It is not known whether or not accumulation or distribution has taken place until the market either breaks above the high range or below the low range of the line.

According to Dow Theory, the formation of a line can act as the equivalent of a market decline or secondary reaction in a bull market if it lasts for over eight weeks. In this instance, the line lasted exactly 8 weeks. I’m hesitant to accept that the “rule” of 8 weeks can be trusted altogether. However, the upward bias of the market has indicated that the most recent breakout will be followed until proven otherwise. It is important to note that secondary reactions act as a release valve from built-up pressure in the market. The fact that the market has responded by breaking above the line that had been drawn indicates that the market has successfully absorbed the large amount of shares that have been distributed by corporations as well as the negative economic news since the March 2009 low.

Because the Dow Industrials and the Dow Transports have both broken to brand new highs at the same time, along with the fact that the Dow Industrials have broken above the line that has been drawn since November 9, 2009, we can safely guess that the market has little desire to go lower and that the bull market is still in place.

Below are the charts of the Dow Industrials and Dow Transports retracements from their respective peaks in 2007. The Dow Industrials have retraced more than 50% of the prior peak while the Transports have retraced more than 60% of the prior peak. This suggests a possible move to retest the high of 14,000 and 5,400. According to Charles Dow, if the market can retrace more than half of the prior move, it (the market) will likely go to the old level that was previously established. One way this was demonstrated was during the decline from October 2007 to March 2009. The decline that took place accelerated significantly once the Dow Industrials exceeded 50% of the rise from September 2002 to October 2007. Likewise, we should be on the lookout for a similar accelerated rise in the market on the way to 14,000.

In an October 15, 2009 article, I charted what I believe to be two scenarios where the market would go. In the first scenario, I suggested that the Dow Industrials would continue on an upward trajectory. Basically, I connected the March 9, 2009 low with the low of July 2009 into the future. In the other scenario, I suggested that the Dow would be able to decline back to the July 2009 low and still be considered a bull market. Additionally, using cycle analysis, I suggested that the market would reach its respective lows between the period of December 2009 and late February 2010.

Since writing the article on October 15, 2009, the Dow Industrials have remained above the upward (red) trendline (see chart below.) I continue to believe that the strongest resistance for the market will be when the Dow Industrials get to 10,700. At this juncture, the Dow Industrials will either break out to the upside in dramatic fashion or retrace back to 9,500. However, given the strong indications from the Dow Industrials and Dow Transports on Friday, I suspect that we can reach 12,000 not long after the month of February 2010.

Considering that this is a cyclical bull market, within the context of a secular bear market, I understand that a reaction of 100% (going back to 14,164 on the Dow Industrials) is not unusual. Additionally, valuations of the market are not at historical lows. Investors should seek out quality companies that are at or near a new low that seem to have viable business models. My preference tends to favor Dividend Achievers or companies that have increased their dividend at least 10 years in a row. -Touc

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Dow Theory

Posted on September 24, 2009 by | Comments Off on Dow Theory
November 4, 2008 is proving to be a significant challenge for the stock market. I have mentioned many times the considerable amount of resistance that November 4th would have on the The Dow Industrials and Dow Transports. However, if viewed from the perspective of a composite index, an index that includes all the stocks in the Dow Industrials, Dow Transports and Dow Utility Indexes, we get a picture that is undeniably negative in the short term.

In the chart below, we see a one year diagram of the Dow Jones Composite index of 65 companies. The composite index briefly exceeded the November 4, 2008 high of 3407.33 by only 1.82 points on September 16, 2009. It is important to know that the high for the day of September 16, 2009 did not exceed the high for the day of November 4, 2008. The fact that the market cannot go above November 4, 2008 so far has much broader implications than just in the financial arena.

Since the September 16th peak the Dow Jones Composite Index has traced out an interesting pattern lower. This same pattern could not be seen if you looked at any one of the individual indexes alone. In the chart below, we can see where the next destination might be for the markets on the downside.

The following are the prospective downside targets for the Dow Jones Composite Index as represented in the inverted chart above:

  • 3293.86-A
  • 3185.02-B
  • 3151.72-C
  • 3125.28-D
  • 2812.05-E

Why have I inverted the chart of the index? Because there is uniform agreement among all great Dow Theorists that calling a peak is the most challenging thing to do. It is the nature of humans to be positive, otherwise most progress isn't possible. With the chart showing a bottom instead of a peak we can feel comfortable seeing the prospects for the future. In terms of Dow Theory, the inverted chart allows us to see a bear market from the same context that we can see a potential bull market.

Now, to play further mind games on you, I recommend that you look at the most recent trend of the Composite Index. After posting above the 3407.33 on September 16th at 3409.15, the market has exhibited two lower peaks on the September 18th and September 22nd. This indicates that a market breakdown to the 3293.86 level (point A) is a probability.
The declines that I have mentioned are in the context of a cyclical bull market within a larger secular bear market. Any of the declines that I have pointed out are all acceptable and constructive for a bull market. Soon after the declines are out of the way we can expect that the market will retest the old high before going higher (both Transports and Industrials) or confirming the previous declining trend.

If you have questions or thoughts then please email me at the following link.

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