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STATISTICS


Dow Trend Reversing

08/17/11 10:15:16 AM
by Alan R. Northam

Statistical analysis is used to show that a primary change in the trend of the Dow Jones Industrial Average is reversing from a primary bull market to a primary bear market.

Security:   .DJI
Position:   N/A

In my article entitled "Primary Change In Trend" published on August 5, 2011, I presented a statistical analysis of the Dow Jones Industrial Average (DJIA) showing that a warning had been given of a primary change in trend. By "primary" I meant a trend that lasts more than one year. In that article I explained that a price crossing to below the lower two sigma linear regression channel line constituted a warning that a change in the primary trend was taking place.

Today, I present an updated statistical analysis showing that a "signal" instead of a "warning" has been given. A warning is like the yellow light at a traffic intersection, indicating that the signal is about to change, whereas a signal is like the red or green light that calls for action to stop or go. A warning therefore means that a change in trend is about to take place, whereas a signal means that a change in trend is taking place. Let's look at the analysis.

The bottom panel of Figure 1 shows the daily price bars of the Dow Jones Industrial Average (DJIA). This panel shows the 200-day linear regression line (middle upsloping blue line) drawn through 200 days of daily closing price of the DJIA and then extended forward in time.

The 200-day linear regression upper and lower two sigma channel lines are also shown 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 in the change of the trend lays ahead. However, 5% of the time price may move outside the two sigma channel lines before moving back inside the two sigma channel lines.

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 the trend is actually occurring.

FIGURE 1: .DJI, DAILY. This chart shows the daily price chart of the Dow Jones Industrial Average, along with the 200-day linear regression trendline and its upper and lower two and three sigma channel lines. This chart also shows the 200-day linear regression slope indicator and the 200-day R-squared indicator.
Graphic provided by: MetaStock.
 
In Figure 1 it can be seen that price has now moved outside the lower 3 sigma channel line, signaling that a change in trend from a primary bull market to a primary bear market is now taking place. By "primary" I meant the long-term trend, lasting more than one year.

Note that price has now closed below the lower three sigma channel line for five consecutive days. The longer price remains below the three sigma channel line, the more valid the signal. Note that price has been moving upward over the last few days. This is called a correction and is a normal behavior following a long downward rally.

Rallies normally overdo themselves and corrections correct for these excesses. If the breakdown below the lower three sigma channel line is a valid breakdown, then price should find the channel line to present a strong line of resistance. This appears to be the case, as price has moved up to the channel line of several recent occasions but has failed to close back above this channel line.

Next, I want to draw your attention to the linear regression slope indicator in the top panel of Figure 1. This indicator shows the slope of the price trend. Note that this indicator is still above its zero line. This indicates that the slope of the trend in price is still upward.

Recall that a signal is given when price moves below the lower -3 sigma channel line that a change in trend is taking place. However, for the trend to have actually changed, the linear regression slope indicator must move below its zero line.

The signal is analogous to the traffic light at a intersection having turned red but the cars are still moving. A crossing of the linear regression slope indicator to below zero is analogous to the cars having actually stopped. Thus, the linear regression slope indicator indicates that the primary trend has not yet actually changed directions.

Further, the linear regression slope indicator peaked in May and has been moving downward. When the linear regression slope indicator is moving upward, it is an indication of price acceleration much as an automobile accelerates from a stop sign.

However, when the linear regression slope indicator is moving in a downward direction, it is an indication of price deceleration just as an automobile starts to decelerate once the traffic light has turned yellow and then red. Thus, the deceleration of price is also a warning that a change in trend is about to take place.

To complete the analysis, we must take a quick look at the R-squared indicator. When the R-squared indicator moves above its critical level, it is an indication that there is a high confidence level that a new trend is under way. When the R-squared indicator moves below its critical level, it is an indication that there is no longer a high confidence level that the current trend is still in effect and is also a signal that a change in trend is taking place.

In conclusion, the long-term statistical analysis shows that the DJIA remains in a primary bull market. However, the analysis also shows that a change in the primary trend is taking place.



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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