|Figure 1 shows the daily bar chart of the Dow Jones Industrial Average (DJIA), in the bottom panel, over the last year. The top panel shows the diffusion index, the second panel from the top shows the linear regression slope indicator, and the third panel shows the R-squared indicator.|
|FIGURE 1: .DJI, DAILY. This chart shows the daily price chart of the DJIA in the bottom panel along with its 200-day linear regression line and associated channel lines. The diffusion index is in the top panel, the linear regression slope indicator is shown in the second panel from the top, and the R-squared indicator is shown just above the price chart.|
|Graphic provided by: MetaStock.|
|The price chart in the bottom panel shows the daily price bars of the DJIA over the last year. The blue upsloping line is the 200-day linear regression trendline and shows that over the last year, the long-term trend has been sloping in an upward direction. The red upsloping lines are the +1, +2, and +3 sigma channel lines. These lines act as lines of resistance. The green upsloping lines are the -1, -2, and -3 sigma channel lines, which act as lines of support. Note that in mid-May 2012, price broke down below the -1 sigma channel line and has been trading in a narrow range between the -1 sigma channel line and the -2 sigma channel line. This is a sign of weakness in the DJIA in that it does not have the strength to rally back up to the blue upsloping linear regression trendline.|
|The R-squared indicator in the third window is a measure of the strength of the trend. The scale of the R-squared indicator moves from zero or zero percent to 1% or 100%. When this indicator is at 0.0, it indicates that all price movement is random and there is no trend. When this indicator is at 1.0, it indicates that all price movement is trending. When this indicator is at 0.4, as it is currently, it indicates that 40% of the price movement represents the trend and 60% of the price movement is random. Thus, the majority of the price movement is random, a sign of weakness.|
The linear regression slope indicator is in the second panel down from the top of Figure 1. This indicator represents the slope of the trend. Note that in mid-May, this indicator peaked and is now moving downward. The peak represents the end of the period of price acceleration for the long-term uptrend.
From mid-May to early August, this indicator has been moving in a downward direction, indicating a period of price deceleration. Normally, price deceleration occurs as the final stage of a trend. Thus, once this stage is complete a reversal in trend normally occurs. We will know when the trend has reversed from a long-term uptrend to a long-term downtrend when the linear regression slope indicator moves below zero. Note that this indicator continues to move downward toward the zero line.
|The top panel shows the diffusion index. This index is like a magnifying glass and allows us to look below the surface of the DJIA by looking at the 30 individual stocks that make up the index. The green line represents those stocks in statistically significant uptrends. A statistically significant trend exists when a stock is in an uptrend and the R-squared indicator is above its critical level. |
Under these conditions, statistics states that the trend should continue. The red line represents those stocks within the DJIA that are in statistically significant downtrends. Note from this indicator that the number of stocks in statistically significant uptrends is falling off and the number of stocks in statistically significant downtrends is starting to increase. This is an early indication that a reversal in trend could already be taking place. A reversal most often occurs when the green line and the red line cross, as they did in August 2011 and February 2012.
|This statistical analysis of the DJIA shows that the long-term uptrend is most likely in its latter stage as noted by price deceleration, a weakening of the trend, and the fact that the number of stocks making up the index in statistically significant uptrends is falling off and the number of stocks in statistically significant downtrends is on the rise. |
A confirmed reversal in trend will occur once the linear regression slope indicator moves below its zero line and the R-squared indicator moves below its critical level and then moves back above its critical level. A confirmed reversal, if one occurs, is most likely several months away.
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