- 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
