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DJIA Diffusion Index Completes H&S Pattern

03/08/11 08:46:42 AM
by Alan R. Northam

The Dow Jones Industrial Average Diffusion Index signals that the DJIA is ready to turn down.

Security:   .DJI
Position:   N/A

The statistical diffusion index in Figure 1 is an oscillator that moves between zero and 30, where 30 represents the number of securities making up the Dow Jones Industrial Average (DJIA). The indicator measures the number of the DJIA stocks whose 50-day linear regression slope indicator is above zero and whose 50-day R-squared indicator is above its critical level. Thus, this statistical diffusion indicator is made up of the 20 DJIA stocks that are individually in strong intermediate-term uptrends. The current reading of 18 indicates that 18 of the stocks within the DJIA are still in strong uptrends.

FIGURE 1: DJIA DIFFUSION INDEX, DAILY. This figure shows the DJIA diffusion index, a completed head & shoulders pattern, and the linear regression trendline along with its upper and lower channel lines. Note: Lower channel is also the neckline for the H&S pattern.
Graphic provided by: MetaStock.
From mid-August 2010 forward, the statistical diffusion index formed a head & shoulders pattern, so I chose a 130-day time frame to represent this pattern. I then plotted the linear regression trendline with a 130-day time period along with its upper and lower linear regression channel lines at plus and minus one sigma. This means that 83% of the movement of the diffusion index has been above the lower channel line.

So a move below this channel line is a significant event. What I also found interesting is that the lower channel line is moving along the neckline of the head & shoulders pattern. Thus, this makes a move below the lower channel line even more significant, as it is not just a significant statistical event but it also completes a H&S pattern. Note that in Figure 1 the Dow Jones Industrial Average Statistical Diffusion Index has now moved below the lower linear regression extended channel line. This is a significant event in that 83% of the price action has up until this time remained above this line, and thus, a move below this line suggests a change in trading psychology to one of continued weakening of the DJIA stocks. In addition, the diffusion index has also broken down below the neckline of a H&S pattern, signaling a trend reversal.

In conclusion, the statistical analysis of the Dow Jones Industrial Average Statistical Diffusion Index suggests that a change in trading psychology has developed. In addition, the diffusion index has also developed and completed a major trend reversal H&S pattern. As a result, expect the DJIA to continue to weaken and reverse into a bear market trend that could last for many months.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at or by visiting his website at You can also follow him on Twitter @TradersClassrm.

Garland, Tx
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