Archive for the ‘dow theory’ Category


In dow theory, ETF on April 20, 2011 at 4:14 pm

As the NHL hockey playoffs progress, I am reminded of how similar our AlphaDow investment ranking system is to ranking hockey teams.  The Vancouver Canucks clinched the “President’s Trophy” as the best team in the NHL for the year.  They did this on the last day of March, before any other team in the Western Conference even clinched a playoff berth.  What does that mean?  As potential MVP Daniel Sedin so eloquently put it, “it means we played pretty good”.

The Canucks take their #1 ranking into the playoffs which means they get home ice advantage in every round.  Again in the words of Sedin “it doesn’t mean we are guaranteed to win it all, it just means we have a pretty good chance”.  As I read that quote I was inspired me to write this missive.  Allow me to explain:

A lot goes into making a championship team.  It takes strength throughout the organization, from senior management right down to the trainers.  Talent and skill are a given, team chemistry, hard work and perseverance are all a part of crafting a team that is ready to win Lord Stanley’s Cup.  Good coaching and strong drafting go into creating a championship contender.  Sometimes it can take years to bear fruit.

Right now, the top three teams in the Western Conference are:

1.  Vancouver Canucks
2.  San Jose Sharks
3.  Detroit Red Wings

And in the Eastern Conference:

1.  Philadelphia Flyers
2.  Washington Capitals
3.  Boston Bruins

If you had to pick six teams that could potentially win the Stanley Cup, you could do worse than to pick these six.

The same thing can be said for the investment world.  The economic conditions have to be right, management has to make good decisions, strategic acquisitions, hire top talent and execute their business plans.  Just like the NHL, it can take years for the conditions to be “just right”.

Right now the top six “teams” in the Canadian stock marketplace right now are:

1.  Materials
2.  Small Caps
3.  Real Estate Investment Trusts (REITs)

4.  Mid Caps
5.  Energy
6.  Technology

You could do very well by investing 5% of your portfolio in each of these six “teams”.  The good news is that there is an exchange traded fund (ETF) that tracks each one of these categories, and they are simple to buy.

To take this analogy a step further, assume that you bet on each of the top six teams to win the cup, but two of the teams end up losing in the first round of the playoffs (hopefully not the Canucks).  What do you do now?  You still have a chance of having the Cup winner in your remaining four picks.  Why not re-rank the remaining teams and “fill-in” your picks with the highest ranked teams remaining.  This means you would have two new picks for the second round of playoffs to go with your original four remaining picks.  Again, your odds of picking the Stanley Cup winner are not 100%, but they remain pretty good.

We do the same thing in the investment world by “rotating up” into the strongest sectors if one of our investments gets “knocked out” by declining prices.  We simply re-rank the sectors that are not already in our portfolio and spread our remaining capital amongst the strongest areas.  This ensures that we always have our capital working for us in the strongest areas.

Of course, when we invest in stocks, just like hockey, we are not guaranteed of anything.  History is rife with stories of major upsets, like the Philadelphia Flyers as recently as last year, getting into the playoffs on the last day of the regular season and making it all the way to the Stanley Cup Finals.  That said, by spreading our investment dollars around on the strongest performing sectors and stocks, we have a “pretty good chance” of picking a few winners.

As always, if you have any questions on how this relates to your portfolio, please don’t hesitate to contact me at


In black swan, DIA, dow theory, ETF, ETFs, GDX, Gold, OIL, transports, Uncategorized, XIU on June 25, 2009 at 4:03 pm

New Dow Theory Position

New Dow Theory Position

I recently went to an electronics retailer in search of “noise canceling headphones” for my iPod. You know, the kind you see people wearing on the airplane – they “cancel” out any ambient noise (my wife calls them “Sarah canceling headphones”). When you put them on you feel like someone shut the door on a noisy party next door. It makes you focus on the topic at hand. In my case I use the iPod mostly for audiobooks and it makes a big difference.

It made me think: “What if we had noise canceling headphones for the markets?”.  Often times, that’s what Dow Theory feels like to me. It cuts through the clutter of the day to day noise in the financial press and gives you an objective answer as to the primary trend of the market. Beyond a doubt the biggest question I get lately is “Is the Bear market over?”  I’m going to give you the answer in this post. But first a refresher:

1. Dow Theory provides us with a binary answer. That means it’s either 1 or 0. There is no room for interpretation. The “noise” as it were, is cancelled out. A “BEAR” signal is in force until such time as a “BULL” signal has been given. Think of the light switch in your kitchen. Once you turn the lights OFF, you can’t turn them OFF again until you turn them ON. There is a lot of bad information on the web about Dow Theory, including some high priced subscription letters that have made many mistakes in the last two weeks interpreting this exact situation.

2. Charles Dow, writing over 108 years ago, used only daily closing prices. An intra-day high is just more noise that is canceled out. The reason is that Dow felt that a closing price trumped all other intra-day prices because it represented a price that traders and investors were happy to carry home overnight. This showed more of a commitment.  This is important as you will see below.

Now I’m going to give you the answer. As you can guess from the image on this post, we are still in a BEAR market. That’s because the last unique Dow Theory signal was a SELL signal way back in November of 2007. That’s right. The light switch has been OFF since November 2007. We are waiting for a Dow Theory BUY signal if and only if the markets can better their most recent secondary reaction highs. What does that mean? That’s technical mumbo jumbo for “the market has to make higher highs and higher lows”. There’s no doubt that the Dow Industrial stocks have done this. They have bettered the May peak by a good margin. However, Dow required the two indicies to confirm each other. The Transport stocks have stubbornly NOT confirmed the high in the Dow Industrials.   The daily close that we need for a Dow Theory BUY signal is a higher close on the Transportation Average of 3404.11.  Above I stated closing prices were important.  That’s because two weeks ago the Dow Transports were on the verge of giving a signal intra-day, and then reversed and closed lower and therefore failed to “flip the switch” to ON.  Let’s look at a chart to see what I mean:

Dow Theory 24 June 09

Dow Theory 24 June 09

The point I am trying to impress upon you is that the Dow Transportation stocks may “know something” that the Dow Industrials don’t.  The failure of the Transports (lower high in June than in May in lower box above) signals a divergence in the indicies.  William Hamilton, Dow’s understudy, warned of such divergences in the indicies as potential danger spots.


In black swan, DIA, dow theory, Gold, transports on March 12, 2009 at 1:39 am

March 11, 2009… Yesterday’s massive 7% rally on the Dow where 96% of the volume was on rising stocks, lacked enough punch to produce a follow-through of more than 5 Dow points today.  The Bear is still in the marquee position on this site as it has been since November of 2007.  Chart 1 shows the Point and Figure target of the recent breakdown is $47 on the Diamonds (DIA) Dow proxy:


GOLD STALLS… The downside target for Gold remains around $830 based on the sell signal shown in Chart 2.  Declining jewerly demand and lack of catastrophe buying has halted the demand for Gold below it’s all-time high of $1030.


OIL FALLS… On news that the OPEC production cut that was expected March 15th may not materialize.  Is this a new down leg or just a pause after the recent breakout to the upside?  Chart 3 shows the bullish target at $60.  A decline in the US dollar may help oil reach that target.


NDT Conclusion: Continue to focus on capital preservation.   This is still a BEAR market until proven otherwise.  Bear market rallies can be tantalizing opportunities, however, only the most nimble of traders can make money on the long side when the primary trend is down.


In DIA, dow theory, ETF, ETFs, GDX, Gold, XIU on January 10, 2009 at 7:06 pm

New Dow Theory Position

New Dow Theory Position

JANUARY 9th, 2009 —

The Florida Gators won the national college football championship this week. They won it on defense. Coming into the game, the prolific Oklahoma sooners wowed everyone with five straight games of putting up 60 points or more. They hadn’t, however, encountered a defense like the Gators. The Gators shut down the Sooners with their stiffling defense and held them to a stingy 14 points.

The point is that the old saying “defense wins championships” is just as true in the investment world as it is in the football world. You have to defend your investment account from your opponent – in this case the bear market. The year 2008 was a great example of winning using defense, or as you’ve heard me say “winning by not losing”. Take a look at the returns accross the globe in 2008:

Dow Industrials -34.7%

TSX Toronto -36.2%
S&P 500 -39.3%
Dow Transports -24.8%
Dow Utilities 31.7%
NYSE Composite -41.8%
Nasdaq 100 -42.4%
Russell 2000 -37.0%
Gold +4.25%
Paris -42.7%
Frankfurt -52.2%
London -32.0%
Japan -42.1%
Zurich -34.1%
Sydney -44.1%
Shanghai B -69.7%
Hong Kong -48.9%
GOLD HITS RESISTANCE… You may have noticed that the only market that was positive in 2008 was g old. In fact, gold has been up in each of the last six years. That constitutes a bull market in gold. The reasons are plenty — the massive stimulus packages announced by the central banks of the world, the weakness in the US dollar, and the fear caused by the nasty bear market. As you can see in Chart 1, if gold can clear the $875 hurdle, I believe the third phase of the gold bull market will be underway.

THE VIX HITS SUPPORT… Although the market has rallied 20% from the November 20th lows, the primary trend remains down. One of the things that may provide a headwind for the market is the Volatility Index. Remember that this indicator usually goes in the opposite direction of the market. It has declined to a level of support that may indicate that the stock market rally is coming to an end. Chart 2 shows the support level of the VIX and the S&P 500 rally losing steam.

DOW THEORY REMAINS BEARISH… It’s important not to lose sight of the primary trend. The primary trend is like the tide of the ocean. The secondary trend can be likened to the waves on the tide. The past few weeks have been positive waves (secondary trend), however, it is still too early to tell if the tide has turned. This is one of the most perplexing parts of studying the market. If you can get the primary trend right, you can make a lot of money.
QUESTION: What would it take to signal a new primary bull market?
NDT ANSWER: On this point, Dow Theory is open to interpretation. In fact, two other well known Dow Theorists have already turned positive on this market. In strict parlance of Dow Theory, we would need to see either one of the Dow Industrials or Dow Transports decline to new lows (below Nov 20th closing prices of 7522.29 for the DJIA and 2988.99 for the DJT), while the other index doesn’t. This is called a non-confirmation. Then we need to see both rally and exceed the recent peaks of early this week.
QUESTION: We’ve already seen a rally from the Nov 20th lows of over 20%. Is there any way we can profit from any further rally?
NDT ANSWER: Yes. You can buy ahead of the official Dow Theory signal. In fact, one of the biggest criticisms of Dow Theory is that it lags the market. You either have to accept this fact or decide to “jump the gun”. This involves additional risk and it comes down to a personal choice. I prefer to advise my more conservative clients to wait and continue to play defense.
QUESTION: If I was intent on “jumping the gun” what would I buy?
NDT ANSWER: I would buy an Exchange Traded Fund (ETF) that represents the entire Dow Jones Industrial Average (DIA). Right now you could also consider a smaller position in GDX for gold shares, or the XIU on the TSX for the entire Toronto exchange. In total, only buy a position of no more than 20% of your account and use a stop loss 8% under your purchase price.
CONCLUSION: Continue to focus on capital preservation. He who loses the least in a bear market is the winner. There will be plenty of time to make money once the primary trend turns positive.


In dow theory, Gold, OIL on September 22, 2008 at 1:53 pm

GOLD RALLIES ON FLIGHT TO SAFETY… Investors worried about soaring inflation spurred by the bailouts of AIG, Fannie May and Freddie Mac pushed gold up to $878 an ounce. The Federal Reserve in the US is leading the rescue party. An increase in the money supply causes general price levels to rise. Gold is a hedge against such price increases. Also, the Chinese newspaper The China Daily carried an editorial urging diversification out of US$. The buying stampede in gold, known as a “hard” currency, resulted in the largest one-day increase since 1979.

Chart 1

OIL RALLYING AFTER 50% RETRACEMENT… After a massive move in oil to a record $150 a barrel, the July to September correction took prices back near $91. This coincided with an OPEC statement suggesting $90-$95 Oil was acceptable. Now I’m looking for oil to rally back to the declining blue trendline around $107-108.

Chart 2

VIX HITS HIGHEST LEVEL IN YEARS… The market’s “fear” gauge hit levels previously seen only at short-term bottoms in the stock market. Generally, spikes to extreme levels are followed by short-term rallies. Yesterday’s panic selling in US financial stocks may have been one such time. Once the fear starts to subside (as it is today – highlighted in yellow) it usually results in a market rally.

Chart 3


In dow theory, OIL on July 25, 2008 at 5:45 pm
BLACK SWAN…. Naseem Taleb’s new book is entitled “Black Swans”. It depicts the role of chance in life and in the financial markets. Last week the SEC changed the rules on “naked shorting”. This has been one of Wall Street’s dirty little secrets for years, now illuminated by the SEC’s revelations. This was an arrow aimed squarely at the short-sellers of the bank stocks in the US. These people would sell the shares of the banks without owning them, hoping to buy them back at lower prices and thus reap a profit. The SEC essentially dropped a “match” on a very over-sold “gasoline” type situation. The result was the US Financial sector rose 13% by the close of the market on Thursday — a Black Swan. Rarely seen, this event was a 11 standard deviation event. To put this in perspective, a four standard deviation event is supposed to happen once every 31,000 years. (On a bigger scale this is exactly why I have a problem with Modern Portfolio Theory and CAPM….but that is for another day). Major turns in the market are normally marked by such events. I am not turning bullish completely on US bank stocks, however, my bullish antennae are raised.

COMMODITY PRICES FALL… DB Commodities Tracking Index (DBC) which represents a basket of commodities (including crude oil, heating oil, gold, aluminum, corn, and wheat). Chart 2 shows it having broken its 50-day moving average. Another reader asked if the downturn included agricultural markets. Chart 3 shows the DB Agricultural ETF (DBA) already threatening its 200-day average after failing a retest of its March high. Better weather conditions in the Midwest have caused profit-taking in grain markets [DBA includes corn, wheat, soybeans, and sugar].

Chart 2

Chart 3

ENERGY STOCKS DECLINE… As I wrote in my June 4th and June 17th Market Letters, oil prices and energy stocks were due for a pullback. The momentum indicators flashed SELL a the new high in oil, as they did not follow suit. Support should come in around this level at the 200d Moving Average. Moreover, even if oil prices drop to $100 and gas drops to $8, this level represents good value. One stock of note is Petrobank Energy and Resources. At $93 oil, the company will cash flow $640M next year on it’s Bakken property alone. The stock has become a darling of the mutual fund arena and is severely oversold. A bounce back to $50 is not out of the question.

Chart 4

DOW THEORY SELL SIGNAL IS STILL VALID… According to Dow Theory, the Dow Industrials and Dow Transports can give buy and sell signals if they act in unison. Recall I’ve equated this to watching the tide on two shores of the same body of water. Chart 5 shows how the Transports stubbornly refused to make a new lower low when the Industrials broke down from their May high and made a new low.

Chart 5

The Dow subsequently moved to new lows for the year and the Dow Theory sell signal remains in place. The Dow Transports must move above its June 2008 high and the Dow Industrials must move above its May 2008 high to trigger a Dow Theory buy signal.


In black swan, dow theory, transports on June 4, 2008 at 1:34 pm

DOW THEORY GIVES US A WARNING SIGN… This is mostly a reactionary business. I tend to let the markets tell us what to do. After all, it represents the collective wisdom of the thousands of market experts, participants, hedgers, speculators and novices. Everyone’s opinion is distilled into price. For an un-emotional barometer of price activity — I tend to lean on Dow Theory. Over 100 years ago, Charles Dow suggested that the Industrials and Transports must move in unison to give valid signals of the primary trend. If one index makes a new high and the other does not, we have what’s called primary a non-confirmation.

Imagine that you are trying to teach a child how to determine if the tide is coming in or going out. One way to illustrate this would be to put a stick in the sand where the waves currently stop, and then wait for the waves to exceed that stick and move it to the new high point. Dow suggested that in order to be sure that the tide is rising, you would need a friend on the other side of the bay to confirm your observations.

Right now we have the Transports making a new high (see chart 1 below), while the Industrials are a big 1,526 points below their record highs of 14,164.53. Where I live, this is analogous to the waves hitting a new high on Jericho Beach on the West Side of Vancouver, while the waves at Ambleside Beach in West Vancouver are no where near their highest point.

Chart 1
ENERGY STOCKS REACHING THE END OF THEIR SEASONALLY STRONG PERIOD… In each of the last 10 years, had you bought energy stocks at the end of November and held until the end of May, you would have averaged a 19% return. Conversely, the return for the TSX Index from end of April until the end of September over the same period is -0.59%. Given that the majority of the strength in the TSX has come from Energy and Materials the past few months (see red and cyan bars in Chart 2 below), we might be wise to put in some protective stops to protect our profits on Energy stocks.

Chart 2

CONCLUSION: I am cautious in the next three to six weeks. I am modestly bullish of commodities via ETFs like DBC and DBE, and bullish of commodity based currencies like Australian Dollars and Swiss Francs via FXA and FXF. Canadian stocks should benefit from Yen carry trade. Avoid long dated bonds.

THOUGHTS… I just returned from an investment conference in Scottsdale where a parade of analysts took the stage to tell a room full of advisors where to put their clients’ money. A friend of mine nudged me with “ooh, so-and-so is up next – he beat the market last year.” Rather than be impressed I was reminded of Nicholas Taleb’s story in The Black Swan. If 5,000 people flip a coin at the beginning of the year, after 5 years you will have 313 that have flipped 5 heads in a row. If you put these people in suits and call them hedge fund managers, they will each earn seven figures. Of course, their odds of flipping a sixth HEAD is still 50-50.