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Average Directional Movement Index
J
Welles Wilder has developed the Average Directional Index (ADX) to
define trend force, whether the trend will develop further or will
gradually weaken.
The simplest trading method based on the
system of directional movement implies comparison of two direction
indicators: the 14-period +DI (yellow) one and the 14-period –DI
(Green). To do this, one either puts the charts of indicators one on
top of the other, or +DI is subtracted from -DI. W. Wilder recommends
buying when +DI is higher than -DI, and selling when +DI sinks lower
than -DI.
To these simple commercial rules Wells Wilder added "a
rule of points of extreme". It is used to eliminate false signals and
decrease the number of deals. According to the principle of points of
extreme, the "point of extreme" is the point when +DI and -DI cross
each other.
- If +DI raises higher than -DI, this point will be the maximum price of the day when they cross.
- If +DI is lower than -DI, this point will be the minimum price of the day they cross.
The point of extreme is used then as the market entry level.
Thus,
after the signal to buy (+DI is higher than -DI) one must wait till the
price has exceeded the point of extreme, and only then buy.
However, if the price fails to exceed the level of the point of extreme, one should retain the short position.
The market often display's some very familiar patterns of price movement. Once a pattern is established, it becomes the most probable course of future price action until the market changes. There are two types of markets which become important for the beginning trader to identify; trending and trend-less. Each market type has two specific patterns which you will also notice over time.
These market types and patterns can be defined as follows:
Trending - Steady elongated price movements with less than a 45-degree angel with occasional pauses, profit taking, or resting periods.
Uptrends - A pattern of higher highs and higher lows.
Downtrends - A pattern of lower lows and lower highs.
Trend-less - Erratic price movements which are often steep ( greater than 45 -degree angle ) and cannot sustain and therefore must reverse. Although the movements can move many points in a short period of time, they often result in very little net price movement over time.
Choppy - An erratic pattern of higher highs and lower lows.
Sideways - A narrow pattern of lower highs and higher lows.
While up-trend and down-trend days can offer excellent trading results, choppy markets often create stop outs, while sideways markets produce for little in either direction. Our trading objective is to get into a trending market and ride until we make our target objective.