While I like to keep things short and simple when it comes top technical indicators, I continue to look for tools that help interpret the charts. Recently I have been spending time with a momentum indicator that I am finding to be quite useful. Being a New Toy junkie I have to be very careful about indicators because they all have a niche and or specialty. Paralysis of analysis can set in quickly if you are not careful. Having swung way too far in the past, I gained perspective when I began to see the tremendous overlap and redundancy of most indicators. At that point I narrowed my focus and priorities to:
1. The picture. ie. The chart itself (lines, patterns, moving averages etc.)
2. Overbought and oversold characteristics i.e. Stochastics and Wilder's Relative Strength Indicator (WRSI)
3. Divergence i.e. Moving Average Convergence Divergence (MACD)
4. Candlesticks and Volume
These cover just about every reasonable angle you may want to evaluate. I have held tightly to this simplified and efficient team and it has served myself and my students well. So why branch out now? I have been a fan of Wells Wilder (WRSI) for some time and when I began to look closely at his Directional Indicators I became intrigued. I have played with them for while now and would like to introduce you to them. My advice is still to keep it simple. There are well over a hundred indicators and studies out there and you have to be careful of the "Camel's Nose in the Tent" if you know what I mean.
Wells Wilder has contributed a great deal to the field of technical analysis. His version of an RSI (relative strength indicator) is a mainstay as an Overbought / Oversold indicator. He also developed the ADX (Average Directional Index) It has a couple of variations to it as well. I will briefly explain it but I want to focus on it's components, the DMI+ (Positive Directional Indicator) and the DMI- (Negative Directional Indicator). Please note that I hate the titles as they play into tone of the most deadly mind tricks of the market for traders, i.e. positive and negative association with up and down! Please try to think Bullish DMI and Bearish DMI.
OK, the ADX is a blend of DMI+ and DMI-. I find it difficult to get clear signals from ADX but when I look at the components I get some very nice confirmation to my regular technical tools. As a Directional indicator the DMI chart shows Trend Strength. It uses a scale of 0 - 100. Typical readings are from 20 - 40. 20 and lower representing a weak trend and 40 representing strong trend. Readings in the 60 range are rare so you have an indicator that rises as the trend strengthens and falls as it weakens. If the indicator spikes and turns over it may indicate a sharp change in the trend direction.
So we look at the line this way. As it rises (moving above 20) as a trend that is strengthening. As it moves toward 40 it is gaining momentum but as with many things (over bought indicators) it can also be reaching an exhaustion point. That may be followed by a retracement or a reversal. A rising line (strengthening trend) flatten out the trend may continue but momentum is backing off. When the line turns down the trend is threatened.
By it's self then indicator is marginal because you don't have a frame of reference i.e. Support and Resistance or other pattern. Used with your existing tools and knowledge it can be very enlightening.
Usually the DMI+ is a green line and DMI- is a red line. Plotting both can be confusing because both are read the same way. The rising line means a stronger trend so rising red means stronger downtrend and rising green a stronger uptrend. The crossover points are often the reversal points and signal retracement or reversal.
The indicator is not helpful when the chart pattern is in compression or flat. It is a trend indicator.
At line A, the DMI- (redline) hits 20 and starts up as the stock rolls over to the downside. It climbs steadily until line B. At line B, the (DMI+ (green line) hits 20 and starts up as the stock reverses to the up side. At line C, the trend breaks as the two lines cross. The green stay above the red and the green rises to the 40-range line. At line D the Red turns up sharply as the green rolls over. The downtrend is marked by the breaking of the support line and continues to line E but the trend strength is weak, as the red line does not rise very strong. The upswing is also weak and a trading range (evident to the eye) is causing the indicator to give muddy signals.
Now we can look at a consensus of experts. Line A, Stochs - Overbought, WRSI- Overbought, MACD - Rolling over, DMI- gaining strength in a downtrend. Line B, Stochs and WRSI - oversold, MACD - along for the ride, DMI- Strong down trend, Trend intact Line C, Stochs and WRSI correcting to the upside & room to go, MACD - "I agree", DMI- weak, DMI+ rising off the 20 and crossing DMI- Trend reversing Line D, Stochs and WRSI - overbought, MACD still just agreeing with chart, DMI+ weakening, DMI- lifting up off 20, Trend is threatened, watch support line. Line E, Stochs and WRSI - oversold, MACD still saying "Yup, me too", DMI= and DMI- irrelevant indicating no trend strength either direction. What followed was a lazy roll out into a sideways trading range. The other indicators can help in a trading range but now DMI says "Sorry, can't help ya".
This indicator may work well if used in concert with the Overbought / Oversold and Divergence indicators and be helpful to reading trend strength but it should be used to augment and not replace or overrule what you have already come to trust, namely the patterns. FIND THE PATTERN and PLAY IT TIL' IT BREAKS.
By Ryan Litchfield with Better Trades
Article Source :http://infopool.webverve.com/
