<s> Stocks & Commodities V. 20:1 (22-25): Detecting Trend Direction And Strength by Barbara Star, Ph.D.TRADING BASICS
Combine ADX And MACD
Detecting Trend DirectionAnd StrengthUsing an indicator by itself can reveal a portionof the entire picture. Combining it with anothercan reveal more.
by Barbara Star, Ph.D.raders use technical indicators torecognize market changes. Theylook to indicators for signs ofprice direction, momentum shifts,and market volatility. Among themost sought-after indicators arethose that identify price trends. Traditionally,moving averages serve that purpose, but theysuffer from whipsaw action during priceconsolidations. However, there is anotherapproach. This article shows how to combine twopopular indicators to help traders detect not onlytrend direction but also trend strength.The indicators involved are the averagedirectional index (ADX) and the moving averageconvergence/divergence (MACD). The ADXfunctions as a trend detector, rising as pricestrengthens into an identifiable trend and fallingwhen price moves sideways or loses its trendingpower. ADX values in the 20 to 30 range indicatemild to moderate trending behavior, whilevalues above 30 usually signify a strong trend.Unfortunately, the ADX does not reveal thetrend direction. The MACD, on the other hand,indicates price momentum and can also be usedto identify price direction as it rises above itstrigger line or falls below its zero line.When both indicators are plotted on thesame chart, trend strength and trend directionbecome clear. The chart of AOL Time Warner(AOL) in Figure 1 illustrates how the twoindicators complement each other. The ADXin the upper panel rose from April throughMay 2001, indicating a trending market. TheMACD rose above its dotted trigger line and itszero line, showing that price direction was up.During July and August the ADX rose onceagain, but the MACD was then below its triggerCopyright (c) Technical Analysis Inc.
PETER NEUMANN
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Stocks & Commodities V. 20:1 (22-25): Detecting Trend Direction And Strength by Barbara Star, Ph.D.
THE CONFIRMING PATTERNMost traders prefer the long side of the marketand look for an uptrending market. Theconfirming pattern identifies exactly thatcondition. When the ADX and MACD moveup in unison, they confirm rising pricedirection; the Bristol-Myers Squibb Co.(BMY) chart in Figure 2 offers a good exampleof a confirming pattern. The ADX and MACDrose as price moved up strongly in Septemberto December 2000.When price changed direction in January2001, both the ADX and MACD followed suit.The falling ADX was not indicating that adowntrend had begun; merely that it no longercould find a trend. In this example, the MACDshowed that price was retracing its prior upwardmarch. But sometimes when both indicatorsfall, price forms a sideways trading range, ratherthan the more pronounced downward moveseen in this chart.
Rising ADX
Rising ADX
Price Direction UpPrice Direction Down
METASTOCK (EQUIS INTERNATIONAL)
line and its zero line, showing that a downtrendwas in progress.
FIGURE 1: ADX AND MACD WITH AOL TIME WARNER (AOL). The rising ADX in the upper panel doesnot differentiate between up- or downtrending price movements. Plotting the MACD just below the ADXmakes the trend direction much easier to spot.
Strong Uptrend
THE DIVERGING PATTERNThe indicator combination shines when a pricedowntrend is in progress and they form adivergence. The ADX rises as it identifies thetrend, while the MACD falls below its triggerline and often below its zero line. The twoindicators no longer move in tandem; instead,they diverge and form almost a mirror image ofeach other. During the severe 2000–01 declinein Cisco Systems (CSCO), the ADX-MACDcombination formed several easily identifiablediverging patterns as one rose and the other fell(Figure 3). They reflected the falling prices inSeptember–October and December 2000 timeperiods, as well as the continuing decline inFebruary–March 2001.The diverging indicator pattern should warnthose who want to go bullish to stay out of astock. However, for those who wish to sellstocks short or purchase put options, thediverging pattern provides a visual gold mine.But expect a price shift when the indicators stopmoving apart and begin to move toward eachother (as they did in April and May).
FIGURE 2: A CONFIRMING PATTERN ON BRISTOL-MYERS SQUIBB (BMY). Both the ADX and theMACD signal a rising trend is in progress when they move up together with price.
DivergenceDivergence
THE CONSOLIDATING PATTERNPrices tend to consolidate periodically duringan uptrending move prior to continuing thetrend or changing direction. The indicatorshighlight a price consolidation when the ADXfalls, while the MACD remains near or above its
FIGURE 3: A DIVERGING PATTERN ON CISCO SYSTEMS, INC. (CSCO). The indicators highlight adowntrend by diverging and forming a mirror-like image.
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Stocks & Commodities V. 20:1 (22-25): Detecting Trend Direction And Strength by Barbara Star, Ph.D.
zero line. This pattern often occurs following aconfirming pattern, as the chart of Bank ofAmerica Corp. (BAC) in Figure 4 illustrates.Both indicators rose during the price uptrendin December 2000 and January 2001. Bothindicators fell as price declined in February2001. But the ADX continued to decline, whileMACD remained at or above its zero line as priceentered a trading range consolidation in Marchand April. Once prices resumed their upmove inMay, both indicators once again began to rise.
MACD at or above zero line
SOMEConsolidation
FIGURE 4: A CONSOLIDATION PATTERN. The box shows price consolidation that followed a priceuptrend in Bank of America (BAC) stock. The ADX declined but the MACD remained above zero toreflect the consolidation.
E
CA
B
F
D
FIGURE 5: ADX WITH TOYS “R” US (TOY). By itself, the ADX can be confusing to interpret becauseits ups and downs do not necessarily follow price.
1
2
3
OBSERVATIONS• ADX: The ADX can beconfusing because it isinterpreted differentlyfrom other indicators.Most indicators move upwhen prices rise, andthey fall when pricesdecline. As seen in thechart of Toys “R” Us (TOY) (Figure 5), that wasnot necessarily the case with the ADX.At point A the ADX was rising while pricemoved down. The ADX pulled back slightly atpoint B as prices rose. However, at point C theADX rose in conjunction with prices. The ADXdeclined between points C and D, while pricemoved sideways before resuming the uptrendindicated by point D. The ADX dip into point Eparalleled a price decline during June. But insteadof a continuation of the preceding uptrend, thenext ADX rise at point F was met with a furtherdecline in price. The moral? Don’t try to secondguess price direction with the ADX.
• MACD: Even the venerable MACD misleadsus at times. Often, we forget the MACD isbasically a momentum indicator, so it does notalways accurately reflect price movement either.Figure 6 displays an example with AT&T (T).In addition to the ADX and MACD in the upperpanels, I plotted a 13-unit simple moving averageof price on the chart. The 13-unit moving averagetends to correspond with the MACD solid linecrossing above and below its dotted trigger linewhen the MACD is accurately tracking price.
13-unit moving average
FIGURE 6: MACD WITH AT&T (T). Because it is a momentum indicator, the MACD does not alwaystrack price accurately.
The combination can helptraders stay on the rightside of the market andincrease the probability ofsuccessful trading results.
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Stocks & Commodities V. 20:1 (22-25): Detecting Trend Direction And Strength by Barbara Star, Ph.D.
At point 1, the MACD solid line rose above its trigger line,which reflected the upmove in price. At point 2 the MACDcrossed below its dotted line, following price to the downside.However, the MACD rise above its trigger line at point 3 wasnot joined by rising prices or an upsloping moving average.The MACD rose because downward momentum pressure haddiminished as prices slowed their downward descent.• Indicator combo: As the charts show, both the MACD andthe ADX register their signals after the start of a price move,with the ADX slower to respond than the MACD. That meansthe indicator combination will not pinpoint tops and bottoms.
However, traders can expect the ADX–MACD combination toidentify and capture part of a trending move. More important,it can help traders stay on the right side of the market andincrease the probability of successful trading results.Barbara Star is a part-time trader and former universityprofessor. She is a past vice president of the Market Analystsof Southern California and led a MetaStock users group formany years. She is a frequent contributor to TechnicalAnalysis of STOCKS & COMMODITIES. Currently, she providesindividual instruction and consultation to those interested intechnical analysis.S&C
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Stocks & Commodities V. 18:4 (62-68): Picking Out Your Trading Trend by Martin J. PringCLASSIC TECHNIQUES
Pick Out YourTrading Trend
PRIMARY TRENDBear market9-months -2 years
Bull market9-months -2 years
There are three kinds of trends: short, intermediate, and longterm. This veteran trader and analyst explains how you canspot them and use them.
Approximately 4-years
by Martin J. PringFIGURE 1: PRIMARY TREND. The classic four-year trend is broken almost equally into
echnical analysis assumes that all bull and bear modes.the knowledge, hopes, and fears ofboth active and inactive market trend (Figure 1) is often referred to as a bull or bear market.participants are reflected in one Bulls go up and bears go down. Typically, they last fromthing: the price. Even if I am in a about nine months to two years, while the bear marketcash position, I am still influenc- troughs are separated by just under four years. These trendsing the price because it would be revolve around the business cycle and tend to repeat. This ishigher if my cash were invested. true whether the weak phase of the cycle is an actual recessionThus, prices are determined by or there is no recession or growth.psychology. This would just be an interesting observation,A fourth category, the secular trend, embraces severalexcept that psychology moves in trends, and so do prices.primary trends and lasts between 10 and 25 years. An exMost of the technical tools we use are aimed at identifying ample using US bond yields between the 1930s and the 1990strend reversals at an early stage. We ride on trends until the can be seen in Figure 2.weight of the evidence shows or proves that the trend hasPrimary trends are not straight-line affairs, but consist ofreversed — in this case, the number of reliable technical a series of rallies and reactions. Those rallies and reactionsindicators all pointing inthe same direction.US GOVERNMENT BOND PRICESHence, the greater thenumber of indicators signaling a reversal, thegreater the probabilitySecular downtrendthat a reversal will takeplace. It is important toremember that technicalanalysis only deals inprobabilities, never cerSecular uptrendtainties. Unfortunately,there is no known methodof forecasting the duration and magnitude of atrend with any degree ofconsistency. Identifyingreversals is hard enough.What is a trend? Howlong do they last? Beforethe advent of intradaycharts, there were threegenerally accepted durations — primary, intermediate, and short-term. FIGURE 2: SECULAR BOND TRENDS. In 1982, the downtrend in bond prices broke along with inflation, setting off the greatest stock bullThe main or primary market in history.Copyright (c) Technical Analysis Inc.
METASTOCK (EQUIS INTERNATIONAL)
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MARCI RASMUSSEN
Stocks & Commodities V. 18:4 (62-68): Picking Out Your Trading Trend by Martin J. Pring
are known as intermediate trends and are represented inFigure 3 by the solid blue line. They can vary in length fromas little as six weeks to as much as nine months — the lengthof a very short primary trend. Intermediate trends typicallydevelop as a result of changing perceptions concerning economic, financial, or political events.It is important to have some understanding about thedirection of the main or primary trend. This is because ralliesin bull markets are strong and reactions weak, as shown inFigure 3. On the other hand, bear market reactions are strongwhile rallies are short, sharp, and generally unpredictable. Ifyou have a fix on the underlying primary trend, then you will
be better prepared for the nature of the intermediate ralliesand reactions that will unfold.Classic technical theory holds that each bull market contains three intermediate cycles, as does each primary bearmarket (Figure 4). I would use this only as a guide, sincemany primary trends are not easily classified this way. Thus,if you are waiting for that third intermediate cycle in a bullmarket, it may never materialize.In turn, intermediate trends can be broken down into shortterm trends that last from as little as two weeks to as much asfive or six weeks. They can be seen in Figure 5, representedby the dashed red lines.
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Stocks & Commodities V. 18:4 (62-68): Picking Out Your Trading Trend by Martin J. Pring
CALCULATING THE KSTThe suggested parameters for short,intermediate and long term can beShort-term (D)10101 15 10 2 2010 33015 4found in sidebar Figure 1. ThereShort-term(W)33E144E266E3108E4are three steps to calculating theIntermediate-term(W)10101131321515320204KST indicator. First, calculate thefour different rates of change. ReIntermediate-term (W) 10 10E1 13 13E 2 15 15E 320 20E 4calling the formula for rate ofLong-term (M)961 126 2 186 3249 4change (ROC) is today’s closingLong-term (W)39 26E1 52 26E 2 78 26E 3 104 39E 4price divided by the closing price nIt is possible to program all KST formulas into MetaStock and the CompuTrac SNAP module.days ago. This result is then multi(D) Based on daily data. (W) Based on weekly data. (M) Based on monthly data. (E) EMA.plied by 100. Then subtract 100 toobtain a rate of change index thatSIDEBAR FIGURE 1: The ROC column is the rate of change. The MA column is the moving average value,and E after the moving average value indicates that the moving average is an exponential moving average.uses zero as the center point. SecMultiply each smoothed ROC by its weight prior to summing the four smoothed ROCs.ond, smooth each ROC with either asimple or exponential moving average (EMA). Third, multiply each smoothed ROC by itsCell G20 is a six-week ROC:prospective weight and sum the weighted smoothed ROCs.=((B20/B15)*100)-100The formula for an exponential moving average (EMA)requires the use of a smoothing constant (α) alpha. TheCell H20 is a six-week EMA:constant used to smooth the data is found using the formula=H19+0.29*(G20-H19)2/(n+1). For example, for n=3, then α = 2/(3+1)=0.50. Theformula for the EMA is:Cell I20 is a 10-week ROC:=((B20/B11)*100)-100E2 = E1 + α (P2 - E1)Cell J20 is an eight-week EMA:where:=J19+0.22*(I20-J19)E2 = New exponential average
Please note the first day’s calculation does not have a priorexponential average. Consequently, you just use the firstday’s price and begin the smoothing process the next day.Figure 2 is a spreadsheet example of the short-term weeklyKST using exponential moving averages for the smoothing.Column C is the three-week rate of change. The formula forcell C20 is:=((B20/B18)*100)-100The three-week rate of change is smoothed with athree-week EMA. The constant used to smooth thedata is found using the formula 2/(n+1). For n=3,then, the constant equals 2/(3+1)=0.50, and thus, theformula for cell D20 is:=D19+0.5*(C20-D19)Cell E20 is a four-week ROC:=((B20/B17)*100)-100Cell F20 is a four-week EMA:=F19+0.4*(E20-F19)
1234567891 01 11 21 31 41 51 61 71 81 92 0
Finally, cell K20 is the summed weighted smoothed ROCs.Each smoothed ROC is weighted according to sidebarFigure 1 and summed:=D20+(2*F20)+(3*H20)+(4*J20)—Editor
ABCDEFGHIJKDate S&P 500 3 week 3 Week 4 Week 4 week 6 Week 6 week 10 Week 8 week Summed920103419.34 ROC EMA ROC EMA ROC EMA ROCEMA Weighted920110415.10ROC920117418.86 -0.11920124415.480.09-0.92920131408.78 -2.41-2.41-1.52920207411.09 -1.06-1.73-1.86-1.97920214412.480.91-0.41-0.72 -0.72-0.63920221411.460.09-0.160.66 -0.17-1.77920228412.700.05-0.050.390.05-0.67920306404.44 -1.71-0.88-1.95 -0.75-1.06-3.55920313405.84 -1.66-1.27-1.37 -0.99-1.28 -1.28-2.23920320411.301.700.21-0.34 -0.73-0.29 -0.99-1.80920327403.50 -0.58-0.18-0.23 -0.53-1.93 -1.26-2.88920403401.55 -2.37-1.28-1.06 -0.74-2.70 -1.68-1.77920410404.290.20-0.54-1.70 -1.13-0.04 -1.20-1.65920416416.053.611.543.110.572.52 -0.130.870.87920424409.021.171.351.861.08-0.55 -0.25-0.590.54920501412.53 -0.850.252.041.472.240.47-0.040.426.26920508416.051.720.990.000.883.611.382.870.9610.71
SIDEBAR FIGURE 2: SPREADSHEET FOR SHORT-TERM WEEKLY KST.Here, the KST is calculated using exponential moving averages.
Copyright (c) Technical Analysis Inc.
Courtesy Microsoft Excel
E1 = Prior exponential averageP2 = Current price
Stocks & Commodities V. 18:4 (62-68): Picking Out Your Trading Trend by Martin J. Pring
INTERMEDIATE TRENDCorrectionsare mild
THE MARKET CYCLE MODELNow that all three trends have been discussed, acouple of points are worth making. First, as an investor, it is best to accumulate when the primary trend isin the early stages of reversing from down to up andliquidating when the trend is reversing in the oppositedirection (Figure 6).Second, as traders, we are better off if we positionourselves from the long side in a bull market, sincethat is the time when short-term trends tend to have thegreatest magnitude. By the same token, it does notusually pay to short in a bull market because declinescan be quite brief and reversals to the upside unexpectedly sharp. If you are going to make a mistake, it ismore likely to come from a countercyclical trade(Figure 7). This is where the market cycle modelcomes into play.
USING THE MARKET CYCLE MODEL
Reactionsare strongRalliesare strongRalliesare short
FIGURE 3: INTERMEDIATE TREND. Pulsating in the midst of primary trends are shorter,intermediate trends, giving charts a stairstep appearance.
INTEGRATION OF PRIMARY AND INTERMEDIATE TRENDS
How can you put this into practice? My favoritemethod is to plot three smoothed momentum indicators to mimic the three trends. An example can be seenin Figure 8 using the KST indicator, originally introduced in STOCKS & COMMODITIES in the early 1990s.The formulas for the three trends can be seen in thesidebar, “The KST.”It’s also possible to substitute other smoothed momentum indicators. For example, three suggestedsets of parameters are displayed in Figure 9 for thestochastic indicator. This arrangement is far fromperfect, but it does provide a framework that offersthe trader and investor a road map of the currentconvergence of the short-, intermediate-, and longterm trends. As always, it is important to ensure thatother indicators in the technical toolbox also supportthis type of analysis.This market cycle model approach can be applied tointraday analysis. Obviously, the time frames will differ radically from the primary, intermediate, and shortterm varieties we looked at previously, but the principlestill applies. If you know that a powerful three- to fourday rally is under way, it would be madness to short afour-hour countercyclical move. Clearly, trading fromthe long side would be more appropriate, but you wouldonly know this if you had identified the bullish intradayprimary trend in the first place. I will cover theseshorter-term aspects in another article.
Classic bull markethas 3 intermediatecycles
Classic bear markethas 3 intermediatecycles
3
2
12
1
3
FIGURE 4: THREE INTERMEDIATE CYCLES. An idealized market cycle would havethree waves up and three waves down.
MARKET CYCLE MODEL
Short-termtrend
IN SUMMARYThere are three generally accepted trends: short-,intermediate-, and long-term or primary. Secular, orvery long-term, trends also make up several primarytrends and can last between 10 and 25 years. At theother end of the spectrum, intraday data now providesus with trends of even shorter time spans lasting aslittle as 10 to 15 minutes.
FIGURE 5: MARKET CYCLE MODEL. Inside the intermediate cycles are short-term cyclesthat last from two to six weeks.
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Stocks & Commodities V. 18:4 (62-68): Picking Out Your Trading Trend by Martin J. Pring
MARKET CYCLE MODEL
MARKET CYCLE MODELTime toliquidate
Go long ralliesbut do notshort reactions
Short reactionsbut do notgo long rallies
Time toaccumulate
FIGURE 6: ACCUMULATE/DISTRIBUTE. Naturally, the best time to load up on stocksis when a cycle bottom is at hand. Approaching the top, it’s time to distribute your holdings.
It is important for investors to have some idea of thedirection and maturity of the main trend. Working on theassumption that a rising tide lifts all boats, traders should alsotry to understand the direction of the main trend even thoughthey themselves are only concerned with a short time horizon.A convenient way to chart longer-term trends is to use a
FIGURE 7: DON’T FIGHT THE TREND. When trading in and out during a primary trend,go in the direction of the primary trend, not against it.
smoothed momentum indicator such as the stochastics or KST.Veteran trader and technician Martin J. Pring founded theInternational Institute for Economic Research in 1981. Pringis the author of several books, including the classic Technical Analysis Explained.
MOODY’S AAA BOND YIELDS AND THREE KSTsMoody’s AAA bond yield
Short-termKST
IntermediateKST
Long-term KST
PRIMARY TRENDS
FIGURE 8: KST. This indicator, developed by Pring in the early 1990s, is generally reliable in picking out trends.
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Stocks & Commodities V. 18:4 (62-68): Picking Out Your Trading Trend by Martin J. Pring
MOODY’S AAA BOND YIELDS AND THREE STOCHASTICSAAA yield
Stochastic (3x3x3)
Stochastic (10x10x6)
Stochastic (39x26x23)
PRIMARY TRENDS
FIGURE 9: STOCHASTIC SMOOTHING. Stochastics of differing-length parameters also pick up trends. You can smooth with any of a variety ofmomentum indicators.
RELATED READINGInternational Institute for Economic Research. Internet: http:// www.pring.com/.Pring, Martin J. [1992]. The All-Season Investor, John Wiley& Sons._____ [1993]. Martin Pring On Market Momentum, International Institute for Economic Research.
_____ [1985]. Technical Analysis Explained, McGraw-HillBook Co._____ [1992]. “Rate Of Change,” Technical Analysis ofSTOCKS & COMMODITIES, Volume 10: August._____ [2000]. “Trendline Basics,” Technical Analysis ofSTOCKS & COMMODITIES, Volume 18: March.†See Traders’ Glossary for definition
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Stocks & Commodities V16:9 (425-427): Trading the Trend by Andrew AbrahamNEW TECHNIQUES
TradingThe Trend
indicator originates from the work of J. Welles Wilder Jr. fromhis New Concepts in Technical Trading Systems. The definitionof the true range is defined as the largest of the following:• The difference between today’s high and today’s low• The difference between today’s high and yesterday’s close,or• The difference between today’s low and yesterday’s close.
Simply, if the trend is considered up, then the trend of pricesare composed of upwaves and the downwaves are countertrendmovements. Downward trends are the opposite, seen asdownwaves with countertrend upwaves. Using several toolsand functions, we can design a quantifiable approach todefining these waves. My favorite is the volatility indicator,which is a formula that measures the market volatility byplotting a smoothed average of the true range. The true range
The calculation uses a 21-period weighted average of the truerange, giving higher weight to the true range of the mostrecent bar. The final value is then multiplied by 3.The volatility indicator is used as a stop-and-reverse method.Let’s say the market has been rising, then the volatilityindicator is calculated each day and subtracted from thehighest close during the rising market. The highest close isalways used, even if there has been a series of lower closessince the highest close. If the market closes below thevolatility indicator, then for the next day, the current readingof the volatility indicator is added to the lowest close. Thisstep is followed each day until the market closes above thetrailing volatility indicator.We now have a definition of the trend. An upward trendexists as long as the volatility indicator is below the marketand a downtrend is in force if the volatility indicator is abovethe market. To visualize these waves, we color-code theuptrends blue and the downtrends red (Figures 1 and 2).In addition, we can add a basic description of trends fortrading. We will say that uptrends are made up of waves ofhigher highs, with prior lows not being surpassed. Conversely, downtrends are composed of waves of lower lowsand prior highs not being surpassed. For sustained moves, theupwaves during uptrends will be larger than the countertrenddownwaves, and in downtrends, the downwaves will belarger than the countertrend upwaves. Therefore, we want toonly trade with the trend and buy upwaves in an uptrend andsell short during a downtrend.For example, as can seen in Figure 1, for Chase Manhattan
FIGURE 1: CHASE MANHATTAN BANK. Use the volatility indicator to signal thedirection of the trend. Here, uptrends are in blue, and downtrends are in red.
FIGURE 2: CORN. The trend is down during November, switches direction inJanuary, and returns down in March.
Here’s a volatility indicator, presented here with simpletrend rules for trading various markets.by Andrew Abrahamew traders quickly becomefamilar with two adages: “Thetrend is your friend,” and “Letyour profits run and cut yourlosses.” Many of us, however,have learned the hard way thatthese things are easier said thandone. Why is that? One reasonis lack of recognition, since thetrend itself is rarely clarifiedand defined, let alone where itstarts and ends. So we need a clear explication of what a trendis as well as where its beginning and its end are.