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In a message dated 12/13/98 6:13:12 PM, rwc@xxxxxxxxxxxxx writes:
<< know for me I just don't realize the intended purpose of some of these
indicators and some I THINK I do. So if the list thinks this would be
something you could benefit from being discussed join in.
I'll start with one that has always mystified me but seems to be used a lot
by many.
Is this indicator seems to be designed for breakout systems or money
management exits. Anybody using this a different way or what ever?
ADX
>>
Robert, The following information was extracted from Traders Club Bulletin
#5. If this is the type of information you are seeking you can go to the web
site for a continuation of the ADX discussion in Bulletin #6. Hope this
helps.
(Begin article by Chuck LeBeau) ADX has its limitations. (I’m referring to
Welles Wilders Average Directional Index in case you are a “newbie”.) After
many years of extolling the virtues of the ADX in articles and lectures all
over the world I have become closely associated with this indicator. That’s
fine with me and I don’t mind being considered the resident expert on ADX. It
is an excellent measure of trendiness and a good indicator to be linked with.
However, I think it is a mistake to try and over work or become too dependent
on any one indicator. If you were going to build a house you would need more
than one tool and you wouldn’t try to do it with just a hammer. The same is
true of building systems. The ADX can be a very valuable tool if used
correctly but it has some major shortcomings that everyone should be aware of:
We all know that the ADX is slow. This is because of all the smoothing in the
formula. The basic ingredients are smoothed and then the results are smoothed
again. For example I think it takes more than 30 bars of data to calculate a
14 bar ADX. This smoothing makes the ADX slow but there is an even greater
problem than just the speed of the indicator. The logic of measuring
directional movement makes the ADX very reliable at certain times and very
unreliable at other times.
A rising ADX is a reliable indication of a trend when there has been an
extended sideways period before the trend gets started. Before all the high
tech computer mumbo jumbo we used to simply refer to this sideways period as a
“basing pattern”. The ADX is most effective when it begins to rise from a low
level (low = 15 or less). This low level on the ADX indicates that there has
been a basing pattern for a while. This interpretation is contradictory to
those users of the ADX who want to see the ADX cross above a specified
threshold (usually 20 or 25) to indicate that a trend is underway. This
technique would make the ADX even slower and means you would be confirming a
trend and entering your trade long after the basing pattern was broken. But
even if you were late due to your method of interpreting the ADX, following
the ADX after a base pattern is still quite reliable. The potential problem I
want to bring to your attention in this article is the action of the ADX after
major peaks and valleys.
The logic of the ADX is best visualized as measuring directional movement over
a moving window of data on a bar chart. If we have sideways data in the
window followed by recent trending data (lets think of rising prices but it
could be the reverse), the rising prices would show directional movement
relative to the sideways data at the beginning of our window. The ADX would
promptly rise and call our attention to the fact that there is now a direction
in prices that should continue for a while.
However, if the prices rise for an extended period and then begin to fall
sharply (a typical scenario) we now have a window of data that shows rising
prices followed immediately by falling prices. The ADX formula measures the
rising prices in the window and compares them with the declining prices in the
window. Because the two trends are about equal they cancel each other and the
ADX does not detect any net directional movement. The ADX now begins to
decline indicating that it is finding no net directional movement in the
period measured by the window.
As the window moves forward, eventually the older rising price data falls
outside the back of the window so that the window now contains only the more
recent downward price movement. The ADX suddenly begins to rise rapidly
because the data window at this point contains only one trend. The problem
with this new signal is that the downward trend in prices has been underway
for quite some time and only now has the ADX finally begun to rise. This is
obviously not a good point to be entering a trade to the short side. We are
probably nearer the end of the trend than the beginning.
Remember that the ADX works best after a basing period and is unreliable after
a “V” bottom or top. That’s all for now. I’ll continue this discussion of
the ADX in our next bulletin. (End of article)
For your info, all the past Traders Club Bulletins can be viewed at
http://traderclub.com/bulletin.htm
Chuck LeBeau
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