There are several ways to monitor forecast error over time to make sure that the forecast is performing correctly--that is, the forecast is in control. Forecasts can go "out of control" and start providing inaccurate forecasts for several reasons, including a change in trend, the unanticipated appearance of a cycle, or an irregular variation such as unseasonable weather, a promotional campaign, new competition, or a political event that distracts consumers.
A tracking signal indicates if the forecast is consistently biased high or low. It is computed by dividing the cumulative error by MAD, according to the formula
The tracking signal is recomputed each period, with updated, "running" values of cumulative error and MAD. The movement of the tracking signal is compared to control limits; as long as the tracking signal is within these limits, the forecast is in control.
Forecast errors are typically normally distributed, which results in the following relationship between MAD and the standard deviation of the distribution of error, a:
This enables us to establish statistical control limits for the tracking signal that corresponds to the more familiar normal distribution. For example, statistical control limits of ±3 standard deviations, corresponding to 99.7 percent of the errors, would translate to ±3.75 MADs; that is, 3a ÷ 0.8 = 3.75 MADs. Control limits of ±2 to ±5 MADs are used most frequently.