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DJIA Trend Reversal Ahead

04/22/11 08:27:54 AM
by Alan R. Northam

Statistical analysis is used to show that a trend reversal in the Dow Jones Industrial Average lays ahead.


Security:   .DJI
Position:   N/A

Last week I wrote an article entitled "DJIA Trend Reversal in Progress." In that article I explained the statistics as to why the Dow Jones Industrial Average (DJIA) trend was in a reversal process. It is now a week later and the DJIA has managed to eke out another new higher high. This new high, however, does not change the basic statistical analysis. But since the DJIA has made a new higher high, I think the conclusions of the analysis should now read, "DJIA Trend Reversal Ahead."

The lower panel of Figure 1 shows the 50-day bar chart of the DJIA along with the linear regression trendline (middle green line) and its upper and lower two sigma channel lines. Note that the linear regression trendline and its channel lines continue to point in an upward direction, but note the very shallow upward slope. This is an indication that over the last 50 trading sessions, the DJIA has made very little upward progress. I should add here that as long as the linear regression trendline points upward even ever so slightly, the bias is still bullish and the DJIA can still eke out higher highs.

FIGURE 1: .DJI, DAILY. This chart shows the daily price chart in the bottom panel along with the 50-day linear regression trendline and its upper and lower channel lines, the linear regression slope indicator in the top panel, the R-squared indicator in the second panel, and the relative standard error index in the third.
Graphic provided by: MetaStock.
 
The linear regression slope indicator in the top panel illustrates what has been happening to the slope of the trend. Up until mid-February, the linear regression slope indicator had been moving in an upward direction, indicating an accelerating uptrend. However, in mid-February this indicator starting moving down, indicating deceleration in the uptrend. Please note that even during periods of deceleration, price can still eke out new higher highs. It's just that these new higher highs can take longer to occur and usually don't make significant progress upward. Even though price may manage to make a new higher high during the deceleration process, it still indicates that a reversal in trend lays ahead.

The R-squared indicator is a measure of the strength of the trend. Up until mid-February, this indicator was also moving in an upward direction, indicating a strengthening trend. However, in mid-February it too started to move down, indicating a weakening trend. In late March this indicator moved below its critical level and remains below this level, indicating that the uptrend of the DJIA has weakened to the point where there is no longer a significant uptrend in progress.

The relative standard error index (RSEI) is a measure of volatility. In early March, this index moved above 0.8, indicating extremely high volatility. In statistical analysis of stock market trends, high volatility normally occurs at market turning points. Thus, the RSEI is warning of a change in trend ahead.

In conclusion, price has been decelerating since mid-February and remains just above its zero line. There is no longer a significant uptrend as the R-squared indicator remains just below its critical level, and volatility is extremely high. These indicators all indicate that a reversal in trend lays ahead.

To complete the reversal process, the linear regression slope indicator must move below its zero line, and the R-squared indicator must move above its critical level. Confirmation of a trend change will occur once the relative standard error index moves back below its 0.2 level, indicating a low level of volatility that is consistent with a trend in motion. If all these steps are not completed, then the uptrend of the Dow Jones Industrial Average will most likely continue.




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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