One of the most effective and reliable of the technical indicators is the Average Directional Indicator or ADX. Used correctly the ADX can be a stunningly accurate gauge of market trend strength or weakness and coupled with a complementary indicator, can be very effective in setting up trades using the E-Minis.
The ADX was created by J. Welles Wilder and introduced in his 1978 book,
New Concepts in Technical Trading Systems. Interestingly Wilder, an engineer, is also credited with creating two other well-known technical indicators, the Relative Strength Indicator (RSI) and the Parabolic SAR which are standard indicators in most charting software packages today.
The ADX is made up of three components, the ADX and +DI/-DI. +DI is the positive directional movement indicator while -DI is the negative directional movement indicator. These two indicators are often plotted separately from the ADX to minimize visual clutter. They are designed to indicate the upward or downward (strength/weakness) of trends.
The directional indicators are capable of generating buy and sell signals when they cross. Basically, a buy signal is present when the +DI moves above the -DI and a sell signal is present when the -DI moves above the +DI. However, in volatile market conditions or when issues are in trading ranges, these signals can reverse rapidly resulting in whipsaws. It's generally accepted that the directional indicators alone are not reliable buy/sell indicators.
The third component of Wilder's indicator is the ADX. The ADX is an oscillator plotted on a 0-100 scale. The ADX itself is the moving average of the difference between the +DI and the -DI. Readings above 60 are rare, while a reading above 30 indicates a strong trend. Readings below 20 indicate a weak trend or an issue in a trading range. Keep in mind that the ADX is "trend neutral"; its reading can apply to bull or bear trends - the ADX merely indicates the strength of the trend. Generally speaking, when the ADX begins to rise above 20, a trend may be in its early stages. Conversely, when the ADX begins to fall below 40, the current strong trend may be weakening.
Wilder himself in his book advises that the ADX is best used in more volatile market conditions. He also advocates use of what he calls the "extreme point rule" when implementing trades. For use in the E-Mini issues the ADX provides excellent results when used with a complementary indicator such as moving averages. The ADX is also a useful tool for setting up scans for issues in the beginning stages of trends and to avoid issues mired in trading ranges.
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