Trading Strategies Using Technical Analysis
- Thread starter SwingKing
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Adding to what I have written above. I feel, we are at an extremely important juncture as investors. There are some unbelievable investment opportunities present out there for the next 1-5 years and I sincerely feel, India is at the brink of something really really special. Hence, don't limit to explore yourself and your beliefs just because there is 15-20 % correction expected. Feel your spirit, believe in your vision and set yourself free !
Tc
Tc
Here is the write up by Chuck Lebeau from which I cud find and identify major limitation of ADX....
ADX Has it's Limitations
(I'm referring to Welles Wilders Average Directional Index in case you are a "newbie".) After many years of extolling the virtues of the ADX in articles and lectures all over the world I have become closely associated with this indicator. That's fine with me and I don't mind being considered the resident expert on ADX. It is an excellent measure of trendiness and a good indicator to be linked with.
However, I think it is a mistake to try and over work or become too dependent on any one indicator. If you were going to build a house you would need more than one tool and you wouldn't try to do it with just a hammer. The same is true of building systems. The ADX can be a very valuable tool if used correctly but it has some major shortcomings that everyone should be aware of: We all know that the ADX is slow. This is because of all the smoothing in the formula. The basic ingredients are smoothed and then the results are smoothed again. For example I think it takes more than 30 bars of data to calculate a 14 bar ADX. This smoothing makes the ADX slow but there is an even greater problem than just the speed of the indicator. The logic of measuring directional movement makes the ADX very reliable at certain times and very unreliable at other times.
A rising ADX is a reliable indication of a trend when there has been an extended sideways period before the trend gets started. Before all the high tech computer mumbo jumbo we used to simply refer to this sideways period as a "basing pattern". The ADX is most effective when it begins to rise from a low level (low = 15 or less). This low level on the ADX indicates that there has been a basing pattern for a while. This interpretation is contradictory to those users of the ADX who want to see the ADX cross above a specified threshold (usually 20 or 25) to indicate that a trend is underway. This technique would make the ADX even slower and means you would be confirming a trend and entering your trade long after the basing pattern was broken. But even if you were late due to your method of interpreting the ADX, following the ADX after a base pattern is still quite reliable. The potential problem I want to bring to your attention in this article is the action of the ADX after major peaks and valleys.
The logic of the ADX is best visualized as measuring directional movement over a moving window of data on a bar chart. If we have sideways data in the window followed by recent trending data (lets think of rising prices but it could be the reverse), the rising prices would show directional movement relative to the sideways data at the beginning of our window. The ADX would promptly rise and call our attention to the fact that there is now a direction in prices that should continue for a while.
However, if the prices rise for an extended period and then begin to fall sharply (a typical scenario) we now have a window of data that shows rising prices followed immediately by falling prices. The ADX formula measures the rising prices in the window and compares them with the declining prices in the window. Because the two trends are about equal they cancel each other and the ADX does not detect any net directional movement. The ADX now begins to decline indicating that it is finding no net directional movement in the period measured by the window.
As the window moves forward, eventually the older rising price data falls outside the back of the window so that the window now contains only the more recent downward price movement. The ADX suddenly begins to rise rapidly because the data window at this point contains only one trend. The problem with this new signal is that the downward trend in prices has been underway for quite some time and only now has the ADX finally begun to rise. This is obviously not a good point to be entering a trade to the short side. We are probably nearer the end of the trend than the beginning.
Remember that the ADX works best after a basing period and is unreliable after a "V" bottom or top.
ADX Has it's Limitations
(I'm referring to Welles Wilders Average Directional Index in case you are a "newbie".) After many years of extolling the virtues of the ADX in articles and lectures all over the world I have become closely associated with this indicator. That's fine with me and I don't mind being considered the resident expert on ADX. It is an excellent measure of trendiness and a good indicator to be linked with.
However, I think it is a mistake to try and over work or become too dependent on any one indicator. If you were going to build a house you would need more than one tool and you wouldn't try to do it with just a hammer. The same is true of building systems. The ADX can be a very valuable tool if used correctly but it has some major shortcomings that everyone should be aware of: We all know that the ADX is slow. This is because of all the smoothing in the formula. The basic ingredients are smoothed and then the results are smoothed again. For example I think it takes more than 30 bars of data to calculate a 14 bar ADX. This smoothing makes the ADX slow but there is an even greater problem than just the speed of the indicator. The logic of measuring directional movement makes the ADX very reliable at certain times and very unreliable at other times.
A rising ADX is a reliable indication of a trend when there has been an extended sideways period before the trend gets started. Before all the high tech computer mumbo jumbo we used to simply refer to this sideways period as a "basing pattern". The ADX is most effective when it begins to rise from a low level (low = 15 or less). This low level on the ADX indicates that there has been a basing pattern for a while. This interpretation is contradictory to those users of the ADX who want to see the ADX cross above a specified threshold (usually 20 or 25) to indicate that a trend is underway. This technique would make the ADX even slower and means you would be confirming a trend and entering your trade long after the basing pattern was broken. But even if you were late due to your method of interpreting the ADX, following the ADX after a base pattern is still quite reliable. The potential problem I want to bring to your attention in this article is the action of the ADX after major peaks and valleys.
The logic of the ADX is best visualized as measuring directional movement over a moving window of data on a bar chart. If we have sideways data in the window followed by recent trending data (lets think of rising prices but it could be the reverse), the rising prices would show directional movement relative to the sideways data at the beginning of our window. The ADX would promptly rise and call our attention to the fact that there is now a direction in prices that should continue for a while.
However, if the prices rise for an extended period and then begin to fall sharply (a typical scenario) we now have a window of data that shows rising prices followed immediately by falling prices. The ADX formula measures the rising prices in the window and compares them with the declining prices in the window. Because the two trends are about equal they cancel each other and the ADX does not detect any net directional movement. The ADX now begins to decline indicating that it is finding no net directional movement in the period measured by the window.
As the window moves forward, eventually the older rising price data falls outside the back of the window so that the window now contains only the more recent downward price movement. The ADX suddenly begins to rise rapidly because the data window at this point contains only one trend. The problem with this new signal is that the downward trend in prices has been underway for quite some time and only now has the ADX finally begun to rise. This is obviously not a good point to be entering a trade to the short side. We are probably nearer the end of the trend than the beginning.
Remember that the ADX works best after a basing period and is unreliable after a "V" bottom or top.
I slightly differ on what is mentioned here. I do know a fair bit about most of the indicators out there and hence, although I do agree one should not rely too heavily on one indicator, I also support the view of having absolute mastery over any one of the good indicators.
We don't need to dwell too deep into science to understand why at times trading with one indicator is a good thing. We just need some basic combination theory to understand this. Now, if we have 2 variables, Price and one indicator, we could map out different market specific behavior of these two variables and study them under those conditions. We could then know, how these two variables behaved and what result to expect under those circumstances. Now, as we begin to increase our variables, we find it very tough to monitor and research these variables. Two variables combined with each other, gives a finite combination. But as we begin to introduce more and more variables, the combinations start to increase and hence the result starts to vary. Now, which result to pick in which condition becomes quite a task.
This is precisely why financial markets are something one needs to be at peace with. Some can manage 2-8 indicators, while some can only manage one. The effectiveness however of using 1-2 indicators is no less than using 2-8 indicators. This is just my own experience. Some do believe that the more number of indicators you have, the more accurate the result becomes. I, however, do not voice this view. At the most I prefer to see one indicator. That's it!! Most of the times, price is enough.
Anyhow, the way to master the markets is to approach it step by step. If one picks up one indicator, he should try and research it in and out. It is only then that one can truly master the markets. And once that's done, you'd be in a position to take out money at your own will.
Tc
We don't need to dwell too deep into science to understand why at times trading with one indicator is a good thing. We just need some basic combination theory to understand this. Now, if we have 2 variables, Price and one indicator, we could map out different market specific behavior of these two variables and study them under those conditions. We could then know, how these two variables behaved and what result to expect under those circumstances. Now, as we begin to increase our variables, we find it very tough to monitor and research these variables. Two variables combined with each other, gives a finite combination. But as we begin to introduce more and more variables, the combinations start to increase and hence the result starts to vary. Now, which result to pick in which condition becomes quite a task.
This is precisely why financial markets are something one needs to be at peace with. Some can manage 2-8 indicators, while some can only manage one. The effectiveness however of using 1-2 indicators is no less than using 2-8 indicators. This is just my own experience. Some do believe that the more number of indicators you have, the more accurate the result becomes. I, however, do not voice this view. At the most I prefer to see one indicator. That's it!! Most of the times, price is enough.
Anyhow, the way to master the markets is to approach it step by step. If one picks up one indicator, he should try and research it in and out. It is only then that one can truly master the markets. And once that's done, you'd be in a position to take out money at your own will.
Tc
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