• Directional Movement
  • ADX Indicator
  • ADX  Signals



Directional Movement System

  • Is it trending or is it not?

  • (ADX), (-DI) and (+DI) represent the “Directional Movement System”

  • Identifies whether the market is trending

  • Categorizes securities by their trending characteristics

Directional Movement

Plus DM (+DM)

Minus DM (-DM)

Minus DM (-DM)

Zero DM

Directional Movement Index - DX

  • The sum reflects the total of the percentage of days that experienced directional movement
  • Wilder recommends smoothing out the action of the DX in order to make it indicative of price movements to both the high and low extremes
  • Smoothing is done by taking a 14-day average of DX, creating the average directional movement index or ADX

Interpretation – Trend Strength

  • ADX determines if a security is trending or not
  • A strong trend is present when ADX is above 25
  • No trend is present when ADX below 20

Interpretation – Trend Direction

  • Plus DI and Minus DI determine trend direction

  • Bullish signal when +DI crosses above -DI

  • Bearish signal when +DI crosses below -DI

Interpretation – Directional Movement System

  • The ADX together with the +DI and the –DI create the Average Directional Movement

  • DI signals should be considered when ADX > 25

  • Bullish signal when +DI > -DI and ADX > 25

  • Bearish signal when + DI < -DI and ADX > 25

Interpretation – Extremes

  • The best trend-following signals are given  when the ADX is at a low number and then moves above 25

  • If the ADX is above both DIs and is at an extreme reading, this means that the trend has been in force for some time

  • The high reading in the ADX is a form of overbought or oversold

  • Not a good point for entering new trades

Directional Movement System - Conclusion

  • Trade only trend-following systems when ADX rating is above 25

  • Use the crossovers of the +DI and -DI as signals for entering and exiting the market

  • When ADX is above both DIs and at an extreme reading, this reflects extreme conditions and warns of a correction

In this section, you will learn

  • Parabolic SAR
  • Calculation
  • Signals

Parabolic SAR

  • Parabolic Stop and Reverse (SAR) Indicator was developed by J. Welles Wilder
  • It is also known as Parabolic SAR, just Parabolic, or even PSAR

  • SAR is a trend following indicator that follows a  parabolic arc
  • SAR is also used as a trailing stop technique for money managemen

Parabolic SAR - Calculation

  • It uses the most recent Extreme Price (EP) along with an Acceleration Factor (AF)

 

  • SAR today = SAR yesterday + AF (EP – SAR yesterday)

 

  • EP is the highest high of an uptrend, or the lowest low of a downtrend

 

  • AF is by default 0.02 (2%), increasing by 0.02 (2%) each time a new EP is reached with a maximum of 0.20 (20%)

Parabolic SAR - Plot

  • SAR is plotted as a dotted line, above and below the price

     

  • When prices are above SAR, the market is considered to be bullish
  • When prices are below SAR, the market is considered to be bearish

 

Parabolic SAR – Bullish Signal

  • When the price crosses above the SAR, a long position is entered
  • SAR point starts relatively far from the price and rises as long as the uptrend is in place
  • As the uptrend continues, the SAR accelerates closing its gap between the price
  • SAR follows prices like a trailing stop and continuously protects profits as prices advance
  • When the price crosses below the SAR, the long position is closed and a short position is entered

Parabolic SAR – Bearish Signal

  • When the price crosses below the SAR, a short position is entered
  • SAR point starts relatively far from the price and drops as long as the downtrend remains in place
  • As the trend continues, the SAR accelerates closing its gap between the price
  • SAR follows prices like a trailing stop and continuously protects profits as prices drop
  • When the price touches the SAR, the short position is closed and a long position is entered

 

Parabolic SAR – Conclusion

  • PSAR is a trend-following system that works very well during trending periods
  • In a ranging or sideways market however, It gives a lot of false signals
  • SAR is also used by traders as a trailing stop-loss technique that allows profits to run and minimizes losses
  • It’s a complete trading system that is easy to follow and provides more discipline to the trader