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STATISTICS


Commodity Market Trend Change Warning

08/12/11 09:21:07 AM
by Alan R. Northam

Statistical analysis is used to show that a warning has been given of primary change in the trend of the direction of the commodity market.

Security:   DJP
Position:   N/A

There are many reasons why we should be interested in the primary trend of the iPath Dow Jones-UBS Commodity Index ETF (DJP), and the following is only a partial list. First of all, the business cycle can be broken down into three primary market sectors: bonds, stocks, and commodities.

In the early stage of the business cycle, bonds start to rally ahead of stocks and commodities. During the latter part of the business cycle, bonds and stocks are moving lower while commodities are moving higher. The final stage of the business cycle sees all three market sectors moving lower. Then the whole process starts over and bonds start to rally again.

By following these three market sectors, it is possible to get an idea when the bull market in bonds begins and ends, when the bull market in stocks begins and ends, and when the bull market in commodities begins and ends. These three markets form a basic guidebook to timing the bond market, the stock market, and the commodity market.

Another reason to follow the action of DJP is that it is composed of oil stocks, gold stocks, copper stocks, and silver stocks, among other commodities. By following the trend of the commodity index, it becomes possible to determine the direction that the individual commodities that make up the index should be taking. For example, if the DJP begins a primary bear market, the commodities that make up the commodity index will also start their own individual primary bear markets. Some may turn bearish before the index, some coincidentally with the index, and some after the index.

So let's take a look at the long-term statistical analysis of this index of commodities and see what's going on.

FIGURE 1: DJP, DAILY. This chart shows the daily price chart of the iPath DJ-UBS Commodity ETN (DJP), along with the 200-day linear regression trendline and its upper and lower two and three sigma channel lines.
Graphic provided by: MetaStock.
 
The bottom panel of Figure 1 shows the daily price bars of the Dow Jones Industrial Average (DJIA). This panel also shows the 200-day linear regression line (middle upsloping green line) along with its 200-day linear regression upper and lower two sigma channel lines, as are the upper and lower three sigma channel lines (green dotted lines). The linear regression line itself (the middle green line) represents the primary trend of the market and is often referred to as the linear regression trendline. The upper and lower two sigma channel lines represent the range in which price statistically moves 95% of the time. In the majority of cases, once price moves outside the two sigma channel lines, a warning is given that a high-probability change in the direction of the trend lies ahead. The upper and lower three sigma channel lines represent the range in which price statistically moves 99.7% of the time. Once price moves outside the three sigma channel lines, a signal is given that a change in trend has occurred.

In Figure 1, we can see that price has now moved outside the lower two sigma channel line, warning that a primary change in trend is ahead for this commodity index and this market sector. Sometimes, price will continue to move in an upward direction between the lower two sigma channel line and the lower three sigma channel line before finally turning lower and breaking down below the lower three sigma channel line.

However, once price manages to break down below the three sigma channel line, a signal is given that a change in the primary trend has occurred.


Looking at the three indicators above the price chart, I would first draw your attention to the linear regression slope indicator. Note that this indicator started to turn down during April and May, signaling that a period of price deceleration was beginning. Price deceleration normally occurs just before the end of a trend, so this indicator was starting to warn of a change in trend ahead.

The R-squared indicator also started to turn down during April and May, indicating that the strength of the primary bull market trend in commodities was starting to weaken.

Finally, the relative standard error index (RSEI) moved above 0.8 in June, indicating high volatility in the market. High volatility normally occurs just before a change in trend. Thus, by June, all three of these indicators were signaling that a change in the primary trend of the UBS Commodity exchange traded note (ETN) lay ahead.

In conclusion, the long-term statistical analysis of the iPath DJ-UBS Commodity ETN (DJP) shows that a warning of a primary change from a bull market to a bear market has now been given. However, a signal that a primary change in trend has occurred has not yet been given, but it is most likely just a matter of time before such a signal is given that a primary change in the direction of the commodity market has occurred. Once a signal has occurred that the primary trend for commodities is now in the downward direction, we should expect all commodities that make up this index will also enter into their own individual primary bear market trends.



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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