|In the bottom panel of Figure 1 is shown the daily price chart of the Dow Jones Transportation Average (DJTA) 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: .DJT, DAILY. This chart shows the daily price chart of the Dow Jones Transportation Average 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 DJTA over last year's period. 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 for the first time since September 2011 and has been trading in a narrow range between the -1 sigma channel line and the -2 sigma channel line since then. This is a sign of weakness as the transports do 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 to 1 or from zero percent to 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 0.1, as it is currently, it indicates that 10% of the price movement represents the trend and 90% is random. Thus, the majority of the price movement of the DJTA is now random and is a sign of extreme weakness.
A move below its critical level and the R-squared indicator will further indicate the lack of a statistically significant uptrend. Note that in statistics, a statistically significant trend means that there is a 95% confidence level that the trend will continue. A lack of a statistically significant trend means there is no longer that confidence.
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. This peak represents the end of the period of price acceleration for the long-term uptrend and the beginning of the period of price deceleration. Normally, price deceleration occurs as the final stage of a trend. Thus, once this period of price deceleration is complete, a reversal in trend normally occurs. A reversal in trend occurs when the linear regression slope indicator moves below zero. Note that this indicator continues to move downward and is approaching the zero line.
|The top panel shows the diffusion index. This index is like a magnifying glass and allows us to look between the pours of the skin of the DJTA and examine the 20 individual stocks that make up this index. The green line represents those individual 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 DJTA 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 on the rise. This is an indication that a reversal in trend could already be taking place below the surface. A reversal most often occurs when the green line and the red line cross as they did in August 2011 and March 2012.
|This statistical analysis of the DJTA 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 individual stocks making up the index in statistically significant uptrends is falling 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.|
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