|The long-term statistical analysis of the individual securities that make up the Dow Jones Industrial Average (DJIA) shows that five of these securities are currently in long-term primary bear markets: Bank of America, Cisco Systems, Hewlett-Packard, Microsoft, and Walmart. On August 5, Alcoa (AA) signaled that its bull market run was coming to an end.|
|The lower panel of Figure 1 shows the daily price bars for AA. This figure also shows the 200-day linear regression trendline (middle green line), the upper and lower two sigma channel lines and the upper and lower three sigma channel lines. In the case of a long-term uptrend, statistical analysis shows that when price moves below its lower two sigma channel line, a warning is given that the long-term trend may be coming to an end. Such a warning was given in June 16, which turned out to be false, as price moved back above the lower two sigma channel. |
On July 18, another warning was given that the bull market for AA may be coming to an end. The reason why a violation of the two sigma channel line provides a warning and not an actual change in trend is that the linear regression slope indicator is still above its zero line and the R-squared indicators above its critical level.
On August 5, price closed below its lower three sigma channel line, signaling that the end of the bull market run for AA was taking place. Note that a crossing of the lower two sigma channel line provides a warning but the crossing of the lower three sigma channel line is a signal that the trend is ending.
|FIGURE 1: AA, DAILY. This chart shows the daily price chart of Alcoa in the lower panel along with the 200-day linear regression trendline and its upper and lower two and three sigma channel lines. The top panel shows the linear regression slope indicator and the next lower panel the R-squared indicator, followed by the relative standard error index (RSEI).|
|Graphic provided by: MetaStock.|
|Looking at the linear regression slope indicator in the top panel of Figure 1, we see that this indicator has not yet moved below its zero line but is close to doing so. As long as this indicator remains above its zero line, the long-term trend statistically remains upward. This is why the crossing of the lower three sigma channel line is a signal that the bull market for AA is ending but has not actually done so. The actual end of the bull market occurs when the linear regression slope indicator moves below its zero line. Note that the crossing of the three sigma channel line provides an early warning signal that the trend is ending.|
The next lower panel shows the R-squared indicator. This indicator measures the strength of the current trend. When this indicator is above its critical level and moving upward, it signals that the current trend is strong and getting stronger. When this indicator is below its critical level, it indicates that the current trend has lost its strength. Statistically, we say that the trend no longer has any statistical significance.
Note that on August 15, the R-squared indicator moved below this critical level (hard to see on the chart as the R-squared indicator just moved below its critical level), indicating that the long-term uptrend has lost its strength. This condition leaves the current trend vulnerable for a reversal. Can the long-term trend continue, even though its current condition states that it has no significant strength? Yes, it can, and this does occur from time to time, but the higher probability is that a reversal in trend will most likely occur.
The next lower panel of Figure 1 is that of the relative standard error index (RSEI). This index provides a measure of volatility. Low volatility is normally registered when the RSEI is below 0.2, which normally occurs during a strong trending rally. When the RSEI registers a reading of 0.8 or higher, it is an indication of extremely high volatility. Extremely high volatility normally occurs just before a reversal in trend. Note that this indicator moved above its 0.8 level in August 9 and is a signal of a possible reversal in the long-term trend.
|In conclusion, the statistical analysis shows that the long-term uptrend in AA is coming to an end. The R-squared indicator has now moved below its critical level, indicating that the current long-term uptrend is no longer statistically significant and vulnerable to a reversal. The linear regression slope indicator is close to its zero line and moving downward with no indication of turning back upward. However, a long-term bear market trend has not yet developed. |
To signal the actual change in trend from a long-term uptrend to a long-term downtrend, the linear regression slope indicator must first turn negative by moving below its zero line. Next, the R-squared indicator must move back above its critical level to signal that a newly established downtrend has become statistically significant (a show of strength). This will reduce the trend's vulnerability of failure. Confirmation that a new bear market is in effect comes once the relative standard error index moves below 0.2, signaling low volatility, which normally occurs during a strong rally.
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