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STATISTICS


Is The Bear Going Back To Sleep?

07/13/11 08:57:20 AM
by Alan R. Northam

Several weeks ago, the bear woke up. Is winter over, or is the bear going back to sleep?

Security:   .SPX
Position:   N/A

On June 16, I wrote an article entitled "S&P 500 Turns Into A Bear." In that article I presented statistical analysis showing that the intermediate-term trend of the Standard & Poor's 500 had turned bearish. I also stated that the relative standard error index still needed to move below 0.2 to confirm that the S&P 500 was well on its way to moving lower, which did not occur. Looking at the current chart (Figure 1), we see that the S&P 500 has now broken out above the upper red two sigma linear regression channel line. So is the bear going back to sleep?

FIGURE 1: .SPX, DAILY. This chart shows the daily price chart of the S&P 500 in the bottom panel along with the 50-day intermediate-term linear regression trendlines and their respective upper and lower channel lines, the linear regression slope indicator in the top panel, the R-squared indicator in the second panel, and the RSEI in the third.
Graphic provided by: MetaStock.
 
The first thing we should realize is that from the late April price peak in the S&P 500 until price broke out above the upper channel line, a total of 42 trading days occurred. With five trading days per week, this comes out to eight trading weeks, or two months. Since intermediate-term trends last from a few weeks to a few months, the recent downward intermediate-term trend has satisfied its time length. But is the intermediate-term downtrend over? Let's look at the current intermediate-term statistical analysis.

The S&P 500 has broken out above its upper two sigma channel line. This breakout, while significant in that statistically 95% of the daily trading over the last 50 days occurs between the channel lines, is only a warning that a reversal in the intermediate-term trend is about to occur but has not yet done so. To understand why the intermediate-term trend has not yet reversed, we have to continue the analysis.

Next, we note that the R-squared indicator remains above its critical level. This indicates that there still exists a 95% confidence level that the intermediate-term downtrend is still in progress. However, the indicator is headed down and should it cross to below the critical level, it will remove this level of confidence.

Then we see that the linear regression slope indicator remains below its zero line. This tells us that the slope of the linear regression trendline is still pointing in a downward direction, indicating that the intermediate-term trend is still down. I also note that this indicator is moving in an upward direction, signaling that the downtrend is starting to decelerate. Price deceleration normally occurs near the end of a trend and is a warning that a reversal could lay ahead.

Finally we look at the relative standard error index (RSEI) and see that it has moved above 0.8. This is an indication that there now exists a very high level of price volatility. High levels of price volatility normally occur around reversals in the trend, whereas low levels of volatility occur during a strong trend. Thus, this high level of volatility is also a warning that a reversal in the intermediate-term trend from down to up could lay ahead.


In conclusion, there is plenty of evidence showing that the intermediate-term trend could be on the verge of reversing its direction from down to up, but this has not yet happened. To reverse the current downward intermediate-term trend, the R-squared indicator needs to move below its critical level, followed by a move of the linear regression slope indicator to above its zero line. Then we need to see the R-squared indicator move back above its critical line to indicate that there is now a 95% confidence factor that a new intermediate-term uptrend is in play. This would signal that a new sustainable uptrend has developed.

However, confirmation of this new uptrend would only occur once RSEI moves back below 0.2, indicating a low level of volatility and a strong uptrend in progress. So while the bear has been awakened, it is possible that winter is not over yet and he could turn around, crawl back into his den, and go back to sleep. It is also possible that winter is ending and the bear just woke up a little bit early.



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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