Correlation at Trade10.com- The science of trading market momentum for stocks, options, futures and bonds.

Critical Day Analysis

Our critical day analysis is all about trend reversals. We tell you when there is a high potential for a reversal of the short trend and we've been doing it since 1994 with an 80%* accuracy.

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Correlation

Correlation is a useful tool for determining if relationships exist between securities. A correlation coefficient is the result of a mathematical comparison of how closely related two variables are. The relationship between two variables is said to be highly correlated if a movement in one variable results or takes place at the same time as a similar movement in another variable. A useful feature of correlation analysis is the potential to predict the movement in one security when another security moves. Sometimes, there are securities that lead other securities. In other words a change in price in one results in a later change in price of the other. A high negative correlation means that when a securities price changes, the other security or indicator or otherwise financial vehicle, will often move in the opposite direction. The spot price of fuel can at times have a high negative correlation with the airline industry for obvious reasons. A weakened sector can often lead markets that are in decline due to the higher risk associated with the position. With our critical day analysis, where over 80%* of our signals have been successful in identifying when directional changes in the short trend of the markets will occur, correlation analysis can be of great benefit for traders who trade stocks, options, futures and mutual funds. Stocks and mutual funds that are highly correlated to the major indices will often undergo the same reversal of the short trend that occurs in the major indices.

A chart study of Bank of America and the S&P500 Index.

Correlation analysis is a measure of the degree to which a change in the independent variable will result in a change in the dependent variable. A low correlation coefficient (e.g., ±0.1) suggests that the relationship between the two variables is weak or non-existent. A high correlation coefficient (e.g., ±0.80) indicates that the dependent variable will most likely change when the Independent variable changes. Correlation can also be used for a study between an indicator and a stock or index to help determine the predictive abilities of changes in the indicator. Correlation is not static. In other words, the correlation between two things in the markets does change over time and so a careful understanding that what has happened in the past may not predict what will happen in the future should be part of any basis in trading financial instruments in the market. The next graph shows the Bank of America and Williams %R.

A chart study of the Bank of America showing correlation of two indicators.

The graph above shows that the Williams % R has at times a high correlation. The indicator is forward shifted by 5 days. This helps to identify if the indicator has any predictive qualities. It appears that Williams %R was a useful indicator to be following during June of 2000 with a high correlation and turning down to cross over the upper range prior to the large drop in the Bank of America's stock price in mid June.

Low correlation readings (eg. -.80) indicate that there is a bias for the two variables being compared to move in opposite directions. Be sure to back test and forward test strategies that are derived from correlation analysis as there can be a high volatility between the correlation of two variables.

To the right technical studies are examined in more detail to provide a sense of conformational evidence for traders of the critical day. Click on any of the terms to take a closer look at a technical discussion on that topic. All formations, patterns, indicators and technical tools fail at various times and so should only be used to build a body of evidence in forming a trading decision rather than being solely relied upon. There are a number of valuable studies that lead to intuitive understandings about price and volume but a strong compliment to technical analysis is an understanding of the trends and changes in the fundamentals and economic activity that ultimately lead valuation levels in the markets.

Walk through a critical day

The graphs show a price plot of the Dow Jones Industrials from Sept 28/00 to early November. The First graph ends on November 3/00, two days before an upcoming critical day on November 7/00. Our members looking at the market are expecting a trend reversal to occur due to the high rate of success in our research. Ideally a member will be using their own skills to judge the supply and demand changes, using technical and fundamental indications to confirm suspicions of a reversal, and trade accordingly.
On the second graph we see that the price action on November 6 was a bullish day, reversing the short trend so that the short trend leading into the critical day is now up. A critical day is an expectation of a reversal of the short trend that immediately precedes the critical day. In the case of the November 7 signal, given to members 3 days before, is an indication that the upward moving trend, recognized at the close of November 6 is expected to reverse direction.
On the third graph we can see that November 7 was a low volatility after a large gain on November 6 of about 160 points for the Dow Jones Industrials. The subsequent move over the three days following the November 7 signal saw the Dow Jones Industrials fall 376 points. The next day, November 13, the Dow Jones Industrials lost an additional 83 points with intra-day low a full 609 point loss since the open on the critical day.

Most recent signals

A closer view of the most recent signals. You can see the short trend immediately prior to a successful critical day, reverses coming away from the critical day. Often a failed critical day will indicate a stronger bias in the market for continuation of the trend that was in place prior to the critical day. A failed signal can therefore provide as much information and opportunity as a successful one. Take a look at tech studies to develop a sense of trend reversals and use.