Short-Term Trend Still Downward

11/21/11 08:53:43 AM

by Alan R. Northam

This analysis shows that the Dow Jones Industrial Average remains in a short-term downtrend.

Security: .DJI
Position: N/A

Figure 1 shows the daily price bars of the Dow Jones Industrial Average (DJIA) in the bottom panel along with the 10-day linear regression trendline (solid blue line) and the lower 3 sigma linear regression channel line (dashed green line). The top panel shows the short-term diffusion index followed by the linear regression slope indicator. The third panel down is the R-squared indicator.

FIGURE 1: .DJI, DAILY. This chart shows the daily price chart of the DJIA, in the lower panel along with its upsloping 10-day linear regression trendline, and the lower 3 sigma linear regression channel line. The top panel shows the 10-day diffusion index followed by the linear regression slope indicator. The third panel from the top shows the R-squared indicator.

Graphic provided by: MetaStock.

The bottom panel shows that on November 1, 2011, price broke down below the lower 3 sigma channel line to signal a reversal in the short-term trend of the DJIA from up to down. Following that breakdown, the DJIA rallied upward but reversed back down on November 9, forming a new lower high.

Immediately, the DJIA rallied upward to test this new lower high and again formed yet a new lower high, after which the DJIA started to sell off and made a new lower low on November 17, confirming that a short-term downtrend was underway.

Looking at the linear regression slope indicator, it too indicated that on November 9, the short-term trend had reversed from an uptrend to a downtrend.

The R-squared indicator since November 1 has, however, remained below its critical level, indicating that the newfound short-term downtrend remains vulnerable for a reversal back upward. This indicator needs to move back above its critical level to lend confidence that the new short-term downtrend is here to stay.

Looking at the diffusion index in the top panel, this index shows the number of stocks in a statistically strong short-term uptrend. The last time, all 30 of the DJIA stocks were in strong, short-term uptrends was back on October 14. From that date forward, the DJIA continues to make higher highs.

The last higher high made by price was on October 27. However, at that time, only 19 of the 30 DJIA stocks remained in strong, short-term uptrends, creating a bearish divergence between the diffusion index and the price chart, forming a negative bias. Following the breakdown in price, when it fell below the lower 3 sigma linear regression channel line on November 1, the number of stocks in strong, short-term uptrends has remained below 10, with only two of the Dow 30 stocks currently in strong, short-term uptrends.

Looking at the diffusion index from mid-October onward, it is easy to see that the trend in the number of stocks in a strong, short-term uptrend has continued to fall: This is a bearish sign.

The breakdown below the lower 3 sigma linear regression channel line was a signal that the short-term trend had reversed down. On November 9, when the linear regression slope indicator moved below its zero line, it also indicated that the DJIA had in fact reversed downward. Since then, the DJIA has formed a lower high and a lower low, also confirming the trend reversal from up to down.

The one thing that stands in the way of having confidence that the short-term trend has indeed reversed down is the R-squared indicator. This indicator needs to move above its critical level to signal that, statistically, a 95% confidence level exists that the new downtrend will continue. Until this occurs, the newfound short-term downtrend in the DJIA remains vulnerable to a reversal back upward.

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.