Dow Theory for the 21st Century

Many have tried to improve on the Dow Theory’s results and failed, however I have made changes that do, indeed, improve those results.  Robert Rhea in his The Dow Theory wrote in 1932 the “the usefulness of the Dow Theory improves with age. Certainly a more comprehensive study of the subject is possible with a 35-year record before us than when Dow worked with the figures of only a few years, while those who use it 20 years from now will have a greater advantage than we now enjoy.”  And now over 85 years later, we have an even greater advantage.

In my book Dow Theory for the 21^st Century, Technical Indicators for Improving Your Investment Results, I illustrate several improvements within the framework of Charles Dow’s original thoughts and premises that would have increased the performance of the traditional “Dow’s Theory” over the last 60+ years. The first improvement I added was to begin buying during “capitulation”, a word Charles Dow never uttered but he clearly alluded to with his discussion of the final phase of bear markets when he described “distress selling of sound securities, regardless of their value…..”    Robert Rhea described it as “a semi-panic collapse (and) it is wise to cover short position and even perhaps make commitments for long account”.   There have only been 15 occasions over the past 60+ years when Capitulation, as we measure and identify it, has occurred and each time a Dow Theory Buy signal has followed, about 4 months later, on average.   I say “we” here because one of my sons, Bart, has assisted me in the past on this Market Letter.   One half of those 15 times occurred within a day or two of the Bear market lows – four were on THE day of the lows. The average was 14 days and 4.6% above the lows; the median was within 3 days and 2% of the lows.

The second enhancement was also an original Charles Dow idea: that a secondary reaction lasts “from ten days to sixty days” (Wall Street Journal, January 4^th, 1902) rather than the widely accepted “from three weeks to as many months”.   Things DO happen faster in the 21^st century. This was the thesis of Alvin Toffler’s Future Shock, as well as a premise in my more recent book.  By using Capitulation as the time to start buying and shortening the timeframe for the steps of the Dow Theory to occur, the result is a signal within a month and a half average of Capitulation, and at a 5% better/lower average entry level than the traditional Dow Theory.

Another advancement was not available in Charles Dow’s day; that is adding the broader Standard & Poors 500 Index, in addition to Dow’s own Industrial Average and the Railroad/ Transportation Average.   The definition of bull and bear markets is also involved:  Charles Dow only had 5 years to work with his 2 indices and concluded that a bull market, or bear market was “the great move covered from four to six years”.  He actually thought that a complete market cycle would last 10 years, with 5 years in a bull market and 5 years in a bear market.  We’ve had 115 more years of historic data than Dow had and now know that Bull markets have averaged less than three years, and Bear markets less than a year and a half. Dow’s expectation was fulfilled, however, 100 years after his death when the 2002-07 bull market lasted exactly 5 years to the day.   My own definition is, indeed, specific:  A minimum +19% advance, or a minimum 16% decline, on both the Dow Jones Industrials and the S&P500.  These percentages are reciprocal numbers of each other, unlike the often used plus or minus 20%. When Bull markets meet the +19% threshold they then go on some 93% of the time to at least a +29% gain.  When Bear markets drop 16% they then go on some 69% of the time to at least a -24% decline.  It should be remembered that Dow’s Theory was a barometer to predict the future course of business activity.  A recession follows my definition of a -16% decline some 67% of the time.  Using the standard -20% figure missed three recessions that the -16% definition captured.  I use the attainment of my definition of bear market as a “stop-loss” point for completing a Sell signal, or the definition of bull market as a “stop-buy” in the case of a Buy signal, when such signals had not already been completed by our interpretation of the Dow Theory for the 21^st Century.

You can view the Record of the Dow Theory For The 21st Century below, however the current and Complete table is available for Subscribers only. Results shown include dividends received and interest earned on 3 month Treasuries as received quarterly. Market levels are for the Dow Jones Industrial Average. When Bull/Bear markets become “official” both the DJIA and the S&P500 levels are shown. FYI, the results over the last 70 years have shown a 13.58% annual gain for this Indicator vrs. a 10.74% annual gain for Buy & Hold. The chart below helps you visualize the outperformance and drawdown reduction from the end of 1953 to 11/8/2024:

While most trades were taken in real life, the results are hypothetical and are NOT an indicator of future results and do NOT represent returns that any investor attained

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