DJIA Correction Extending

10/24/11 02:12:35 PM

by Alan R. Northam

This statistical analysis shows that the Dow Jones Industrial Average price correction is extending.

Security: .DJI
Position: N/A

Recently, I wrote that a long-term statistical analysis showed the Dow Jones Industrial Average (DJIA) continuing its downtrend ("DJIA To Continue Downtrend," October 13, 2011). In that article, I also noted that currently the DJIA was undergoing a market correction. I then wrote a follow-up article that explained that the DJIA was currently correcting for its recent losses ("The Trendless DJIA," October 14, 2011). Today, I present a statistical analysis showing that this price correction is now extending.

Figure 1 shows the intermediate-term statistical analysis of the DJIA. The bottom panel shows the daily price bars, the 50-day linear regression trendline (solid blue line), the upper three sigma channel line (dashed red line), and three overhead resistance lines labeled resistance 1, resistance 2, and resistance 3, corresponding to the 200-day, one sigma, two sigma, and three sigma channel lines, respectively. The upper panel shows the 50-day linear regression slope indicator, while the middle panel shows the 50-day R-squared indicator.

FIGURE 1: .DJI, DAILY. This chart shows the daily price chart of the Dow Jones Industrial Average in the lower panel along with its upsloping 50-day linear regression trendline, the upper three sigma channel line as well as three levels of overhead resistance. The top panel shows the linear regression slope indicator followed by the R-squared indicator. This chart shows that the price correction of the DJIA could extend longer and retrace more of its losses.

Graphic provided by: MetaStock.

Looking at the lower panel of Figure 1, note that the DJIA has recently broken out above its upper three sigma channel line (dashed red line), signaling an intermediate-term trend reversal to the upside. The significance of this breakout is that over a 50-day time frame, 99.7% of price volatility occurs between the upper and lower three sigma channel lines. Only 0.3% of the time does price trade outside these boundaries. Thus, it is a significant event when price breaks out above the three sigma channel lines, as it most generally indicates a reversal in trend. Only in extremely rare cases will price reverse back down and continue to trade in the direction of the current trend.

Looking at the linear regression slope indicator in the top panel of Figure 1, note that in mid-October this indicator moved above its zero line, indicating that the intermediate-term trend has reversed upward. A stronger signal, however, occurs when both a three sigma channel line breakout and the linear regression slope indicator cross its zero line.

While price has broken out above its three sigma channel line and the linear regression slope indicator has crossed above its zero line, signaling an intermediate-term price reversal, the R-squared indicator in the middle panel of Figure 1 remains below its critical level. When this indicator is above its critical level, it indicates a 95% confidence level that the trend will continue. However, when the R-squared indicator is below its critical level, as it is now, it indicates that while a reversal in trend has occurred, this new uptrend lacks significance. As long as the R-squared indicator remains below its critical level, the newly established uptrend is nothing more than a continuation of the current price correction.

While the DJIA remains in a long-term downtrend, over the intermediate term, price has been in a correction as it digests its losses. Further, while this correction has lasted almost three months, this analysis shows that this price correction is now extending in both time and retracement. In preparation for this extended price correction, Figure 1 also shows three levels of overhead resistance that are price targets for the end of the extended price correction period. A move above resistance level 3, however, would indicate that the upward price movement is not a price correction but the beginning of a long-term trend reversal.

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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DJIA Correction Extending

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