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Average Directional Index (ADX) and Directional Indicators (+DI,
-DI)
The Average Directional Index (ADX) was developed in order to evaluate the
strength of the current trend, be it up or down. It's important to determine
whether the market is trending or trading (moving sideways), because certain
indicators give more useful results depending on the market doing one or the
other.
ADX is an oscillator that fluctuates between 0 and 100. Even though the
scale is from 0 to 100, readings above 60 are relatively rare. Low
readings, below 20, indicate a weak trend and high readings, above 40,
indicate a strong trend. The indicator does not grade the trend as bullish
or bearish, but merely assesses the strength of the current trend. A
reading above 40 can indicate a strong downtrend as well as a strong
uptrend.
ADX can also be used to identify potential changes in a market from
trending to non-trending. When ADX begins to strengthen from below 20
and/or moves above 20, it is a sign that the trading range is ending and a
trend could be developing.
When ADX begins to weaken from above 40 and/or moves below 40, it is a
sign that the current trend is losing strength and a trading range could
develop.
Positive/Negative Directional Indicators (+DI, -DI) :ADX is derived from two other indicators, (by the same developer, Wilder),
called Positive Directional Indicator (sometimes written +DI) and Negative Directional Indicator (-DI).
Basically, buy and sell signals can be generated by
+DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell
signal when -DI moves above the +DI. Be careful, though; when a security
is in a trading range, this system may produce many whipsaws. As with most technical indicators, +DI/-DI crosses should be
used in conjunction with other technical indicators.
ADX combines +DI with -DI and then smoothes
the data with a
moving average to provide a measurement of trend strength. Because it
uses both +DI and -DI, ADX does not offer any indication of trend
direction, just strength. Generally, readings above 40 indicate a strong
trend and readings below 20 a weak trend. To catch a trend in its early
stages, you might look for stocks with ADX that advances above 20.
Conversely, an ADX decline from above 40 might signal that the current
trend is weakening and a trading range may develop.
Whipsaw A whipsaw occurs when a buy or sell signal is
reversed in a short time. Volatile markets and sensitive indicators can
cause whipsaws. For example, a whipsaw would occur if a position trader
initiates a long position on a bullish
MACD
crossover and has to close it the next day because of a bearish moving
average crossover. The signal was reversed and the trader had to exit
quickly.
MACD (Moving Average Convergence/Divergence)An indicator
that is calculated by subtracting the 26-period
exponential moving average of a given security from its 12-period
exponential moving average. By comparing moving averages, MACD displays
trend following characteristics, and by plotting the difference of the
moving averages as an oscillator, MACD displays momentum characteristics
also.
A positive divergence occurs when MACD begins to advance and the
security is still in a downtrend and makes a lower reaction low. MACD can
either form as a series of higher lows or a second low that is higher than
the previous low. Positive divergences are probably the least common of
the three signals, but are usually the most reliable and lead to the
biggest moves.
Moving Average (MA) An average of data for a certain
number of time periods. It "moves" because for each calculation, the
latest x number of time periods' data is used. A moving average lags the
market. An exponentially smoothed moving average (EMA) gives greater
weight to the more recent data, in an attempt to reduce the lag. |
