Saturday, April 17, 2010
Okay, don't get freaked out by the Stats-101 reference! It's simply a measure of how accurately the predicted trend line is fitting the actual price series! In this case, we are referencing that accuracy level relative to historical norms to decide whether we are in fact in more of a mean-reverting versus a trending environment. Think of it as a "third state".
The color key below employs a smoothed monthly look back period with up-trends in green, down-trends in red, and mean-reversion oriented periods in purple. I expect that this concept could be advanced significantly with further study, but here is a first pass graphical look at the idea going back ten years using the S&P 500 (SPY) as inspiration: