Monday, January 21, 2008

Measuring Trends

The use of linear regression lines along with watching various standard deviations from this mean can show if a sell off is a change in trend or if it just part of the ebb and flow of the overall trend. The chart below shows the Dow Jones Industrial Average. The chart is a 3day chart;meaning each bar represents 3 days worth of data. This acts to smooth the data and helps eliminate noise. The Blue line in bisecting the data is the 377 period linear regression line. The lines above and below this regression line show the various standard deviations from this mean. The White line is +/-1 standard deviation. The Yellow line is +/-1.5 standard deviations, followed by the Red line which is +/-2 standard deviations.

The various deviations can serve as support and resistance as the trend unfolds. It is important to know where the market is trading in relation to its trend.

Dow Jones Industrial Average 3 Day Chart
(Click to Enlarge)

This chart shows the Dow30 has had some wild moves of late, but it is still within only one standard deviation below its long term linear regression line. The market could attempt to find support at this level, but it more likely that any pause will be met with more selling.

The chart below is of the S&P 500 Index. This chart shows this index has broken below 2 standard deviations from its long term linear regression line. This signals a change in trend. Any rallies will most likely be met with selling.

S&P 500 Index

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