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The Trendless DJIA

10/14/11 11:47:58 AM
by Alan R. Northam

This statistical analysis shows that the Dow Jones Industrial Average has no intermediate-term trend.

Security:   .DJI
Position:   N/A

Recently, I wrote that a long-term statistical analysis showed the Dow Jones Industrial Average (DJIA) continuing its downtrend. In that article I also noted that currently the DJIA was undergoing a market correction. Today, I want to take a look at this market correction by offering a shorter-term statistical analysis.

The lower panel of Figure 1 shows the intermediate-term statistical analysis of the DJIA. This figure shows the 50-day linear regression trendline (solid blue line), the upper one sigma channel line (dotted red line), the upper two sigma channel line (solid red line), the upper three sigma channel line (dashed red line), the lower one sigma channel line (dotted green line), and the lower two sigma channel line (solid green line). Besides their statistical significance, the red channel lines act as resistance and the green channel lines support.

FIGURE 1: .DJI, DAILY. This chart shows the daily price chart of the DJIA in the lower panel along with its upsloping 50-day linear regression trendline and its associated upper and lower channel lines. The top panel shows the linear regression slope indicator followed by the R-squared indicator. This chart shows the DJIA trendless over the intermediate-term time frame.
Graphic provided by: MetaStock.
 
Figure 1 shows that the DJIA has recently broken out above the upper two sigma channel line (solid red line) warning of a possible intermediate-term trend reversal to the upside. The reason for the warning is that 95% of the time price movement stays between the upper and lower two sigma channel lines. Only 5% of the time price moves outside the boundaries of the upper and lower two sigma channel lines. This normally occurs when a reversal in trend is at hand. However, on occasion the movement of price outside these boundaries results in a false warning.

A movement of price outside the boundaries of the upper and lower three sigma channel lines is a signal and not just a warming of a reversal in trend. The reason is that 99.7% of the time price movement stays within the upper and lower three sigma channel lines. A breakout from these boundary lines represent a very strong possibility that a reversal in trend is imminent with very few false signals.

Looking at the linear regression slope indicator in the top panel of Figure 1, note that in mid-September this indicator reversed directions from below its zero line and started moving upward. This is an indication of price deceleration. Price deceleration normally occurs near the end of a trend. However, during this period, price can still move to a new lower low as it did in early October. Note that this indicator is now approaching its zero line. A breakout above the zero line will signal a reversal in the intermediate-term trend from down to up.

However, this new uptrend can easily fail for two reasons. The first reason is that price may still remain below the upper three sigma channel line as shown in the bottom panel. Note that the three sigma channel line acts as a line of resistance and price could bounce off this line and reverse back down.

There's another reason.

The R-squared indicator in the middle panel of Figure 1 shows it having recently moved below its critical level. When this indicator is above its critical level, it indicates a 95% confidence level that the current trend will continue. However, when the R-squared indicator moves below its critical level, this high level of confidence no longer exists. In statistical jargon, it is said that when the R-squared indicator is above its critical level, the current trend has statistical significance; however, when it is below its critical level, that statistical significance no longer exists.

Simply, statistical significance means that a trend exists and the lack of statistical significance means there is no trend. With the R-squared indicator currently below its critical level, it can be said that no statistical trend currently exists, even though the linear regression slope indicator in the top panel remains below its zero line, indicating a downslope in the linear regression trendline. Further, once the linear regression slope indicator moves above its zero line, indicating that the linear regression trendline has now reversed from a downsloping line to an upsloping line, as long as the R-squared indicator remains below its critical level, no statistical trend exists.

It is during this period, when there is no statistical significance, that price is vulnerable to a new trend in either direction.

In conclusion, while the DJIA remains in a long-term downtrend, this statistical analysis warns of the possibility of an intermediate-term trend reversal, or correction of the intermediate-term time frame. This analysis further shows that the DJIA is no longer in an intermediate-term downtrend but has not yet entered into an intermediate-term up -- in other words, the DJIA is currently trendless from an intermediate-term perspective.

From a traditional technical analysis point of view, it can be said that the DJIA is trading in a range. This analysis also shows that price has not yet moved above the upper three sigma channel line that acts as a resistance line. Thus, it is possible that this resistance line could turn the DJIA back down to resume its downtrend. However, a break above this line of resistance, and a move above the zero line by the linear regression slope indicator followed by a move above critical level by the R-squared indicator, will indicate a reversal of the intermediate-term trend from down to up.



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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