| History
Average Directional Index (ADX) was developed by
J. Welles Wilder Jr. and as its name implies
attempts to measure the strength of the
direction the security is moving in.
ADX is measured in a scale from 0-100 with
readings above 25 indicating that you are in a
trend whilst readings below 25 indicate that you
are not in a trend.
As the scale is measured from 0-100 it
doesn't matter if the trend is up or down, the
scale and reading are still from 0-100 e.g. if
you were in a strong down trend the reading
might be 45. You might get the exact same
reading if you were in a strong up trend. The
reason I mention this is that many of my
students get confused when first introduced to
ADX and see the indicator
rising as the trend goes down.
Wilder himself admitted that ''Directional
movement is the most fascinating concept I have
ever studied'' 'New Concepts In Technical
Trading Systems'. Readings of over 60 are fairly
rare in my observations and once they are at the
extremes can actually mean the direction is
getting ready for a change.
My Own use Of ADX
I highly recommend this little technique. You
may not get that many signals but when you do
they will be high probability. I like to use a
21 period moving average on the time period I am
trading.
First the ADX must be 30 or over, no action
is taken unless the ADX has achieved this
reading.
Next the security must retrace to its 21
period moving average.
Once these two conditions have been met you
can enter the market. Once in the market keep
two things in mind.
- Have a tight stop on the initial entry,
perhaps above the most recent high or most
recent low depending on direction you are
trading or even a dollar amount.
- Be aware of the last high or low once in
trade e.g. the ADX has a reading 30 or
above, the security makes a high and then
retraces to the 21 period moving average.
Your first target should be the last high or
you should at least pay close attention to
what happens to price around that level.
The same goes for the short trade. You have a
reading of 30 or above and it makes a new low.
It then pulls back to the 21 period moving
average and you enter short. Your first target
should be the previous low or monitor closely at
that price level.
Good Trading
Mark McRae |