Components: +DI, -DI, and ADX. +DI is the positive directional indicator, -DI is the negative directional indicator and the ADX line combines the two with a 14 day moving average to provide the overall trend strength.
The trend strength is measured on a scale of 0-100. Readings below 10 and above 60 are rare. The higher the reading, the stronger the trend.
How can you use the ADX in your trading? Assuming you are looking to buy stocks (either long or short) which have momentum building, you will always look to buy stocks with a rising ADX line. Momentum usually starts to build as the ADX line crosses above 15-20 and continues to strengthen until the ADX line flattens or reverses downwards.
Let's start by looking at a few daily charts on trending stocks from the recent past.
The first chart is a daily view of CMCSK, which has had a lot of bullish momentum lately, despite the weak markets.
Notice how the ADX line (black line) dipped lower in Feb. when price was holding support at $26.00 than it was in Dec. at the same price levels. When the ADX dips lower and price doesn't follow, it is usually an early hint that a big move is going to manifest itself in the near-term so keep the stock on your watch list.
The next area of interest is the beginning of April when price broke out of a decsending triangle pattern at the same time as the 20 and 50 MAs crossed over. The ADX line broke its downtrend line concurrently.
By the time price regained the 200 day MA, the ADX line was crossing 20 and +DI had crossed above -DI. Over the next three weeks, the ADX line went from 20 to 40 and price increased 14% from $28 to $32.
In mid May the ADX curled downward indicating a trading range would come into play, however, the +DI and -DI kissed (see blue arrow) and bounced off of each other reflecting another minor wave of strength.
The following example is a daily chart of ADBE, which has had a similar rise in the ADX line only this time, -DI crossed over +DI, and the momentum was to the downside.
ADBE gapped down on a weak earnings report. What followed was death cross of the 20/50 MAs in conjunction with a bearish ADX crossover and the move was swift - a 21% price move from $36.00 to $28.50 as the ADX line went from 20 to 50 in the space of one month.
Now let's look at an intraday timeframe and see how the ADX can help guide day and swing trades. Here is a chart of CTXS from back in May 2006 which was originally posted on my blog on May 8th and pretty much speaks for itself.
2 comments:
Hi Jamie,
Thanks for the ADX post. It was very informative. How reliable do you think the +DI and -DI indicators are? I've been looking at a few charts, and if a trader went long a stock when the +DI line crossed the -DI line from below and sold the position (or went short) when the -DI line crossed the +DI line from below, it could turn out to be very profitable.
A question in the CTXS chart, did you mean 'overbought' in the stochastics when it was above 80?
Thanks,
AJ
Hi AJ,
You're welcome. I don't recommend using just +DI and -DI as buy and sell signals. I personally use the enitre oscillator to help guide my buy and sell activity. When I first started using it, I tried the +D-D crossover and found there were too many whipsaws.
With regard to CTXS stochastics, yes, I meant overbought.
Good trading!
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