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STATISTICS


DJIA Trend Reversal? Not Yet!

05/24/11 08:07:11 AM
by Alan R. Northam

Statistical analysis is used to show that the Dow Jones Industrial Average remains in an intermediate-term uptrend but also warns that a trend reversal could be just ahead.

Security:   .DJI
Position:   N/A

The lower panel of Figure 1 shows the 50-day bar chart of the Dow Jones Industrial Average (DJIA) along with the linear regression trendline (middle green line) and its upper and lower two sigma channel lines. Note that the linear regression trendline and its channel lines continue to point in an upward direction, indicating that the intermediate-term trend of the DJIA is still up. However, also note that price has recently closed near the lower channel line. A close below the channel will be the first indication that the upward intermediate-term trend has ended.

FIGURE 1: DJIA, DAILY. This chart shows the daily price chart in the bottom panel along with the 50-day linear regression trendline and its upper and lower channel lines, the linear regression slope indicator in the top panel, the R-squared indicator in the second panel, and the relative standard error index in the third.
Graphic provided by: MetaStock.
 
The linear regression slope indicator in the top panel illustrates what has been happening with momentum. From mid-April to early May, this indicator has been moving higher, signaling that price momentum was accelerating, an indication of a healthy upward rally. However, now the slope indicator is rolling over and is starting to point in the downward direction. This is an indication that price is now in the early stage of deceleration. Note that price deceleration normally marks the final stage of an uptrend and occurs just before a reversal in direction. In addition, note that price often still makes a new higher high during the stage of price deceleration. As a result, the linear regression slope indicator is warning that the end of the intermediate-term rally is drawing to an end but has not yet signaled a reversal in direction. A reversal in direction is signaled when this indicator moves below its zero line. From the chart, it can be seen that this indicator has a lot of work to do before it is ready to move below the zero line, and thus it will be several days yet before an official reversal in the intermediate-term trend has been signaled.

The R-squared indicator is a measure of the strength of the trend. From mid-March, when the R-squared indicator moved above its critical level until early May, this indicator has been moving higher, signaling that a strong upward rally was under way. Now, however, this indicator is starting to roll over, signaling that the upward rally is starting to lose strength. A move below its critical level is required to signal that there is no longer a significant upward intermediate-term trend in progress. Again, it will be several days yet before this indicator works its way down to its critical level.

The relative standard error index (RSEI) is a measure of volatility. In early March, this index moved above 0.5, indicating above-average volatility. Shortly thereafter, RSEI moved to above 0.8, signaling that price had entered into a period of high volatility. In statistical analysis of stock market trends, high volatility normally occurs near market turning points. The RSEI started warning of a possible change in trend at that time. However, euphoria caused traders to shrug off this high level of volatility and the warnings that come with it and continued to trade the market higher. More recently, volatility has declined somewhat but continues to remain above average. The relative standard error index continues to warn of a possible trend reversal ahead.

In conclusion, all the indicators cited above warn of a possible trend reversal ahead. However, none of these indicators have yet signaled that a change in trend has occurred. Until these indicators signal a reversal in trend, it is still possible that the DJIA could continue to rally upward and make yet another new higher high. The first sign of a trend reversal will most likely be the breaking down of the lower channel line when price closes below it and the R-squared indicator moves below its critical level.

The formal reversal in the intermediate-term trend will come when the linear regression slope indicator moves below its zero line and the R-squared indicator moves back above its critical level. Finally, confirmation will come when RSEI moves below 0.2, indicating a period of low volatility.



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 inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

Garland, Tx
Website: www.tradersclassroom.com
E-mail address: inquiry@tradersclassroom.com

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