Detecting Trend Direction And Strength

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Usingan indicatorbyitselfcan reveal a portion of the entire picture. Combining it with another can reveal more.

by Barbara Star, Ph.D.

raders use technical indicators to

T recognize market changes. They look to indicators for signs of price direction, momentum shifts, and market volatility. Among the most sought-after indicators are those that identify price trends. Traditionally, moving averages serve that purpose, but they suffer from whipsaw action during price consolidations. However, there is another approach. This article shows how to combine two popular indicators to help traders detect not only trend direction but also trend strength.

The indicators involved are the average directional index (Adx) and the moving average convergence/divergence (Macd). The Adx functions as a trend detector, rising as price strengthens into an identifiable trend and falling when price moves sideways or loses its trending power. Adx values in the 20 to 30 range indicate mild to moderate trending behavior, while values above 30 usually signify a strong trend. Unfortunately, the Adx does not reveal the trend direction. The Macd, on the other hand, indicates price momentum and can also be used to identify price direction as it rises above its trigger line or falls below its zero line.

When both indicators are plotted on the same chart, trend strength and trend direction become clear. The chart of Aol Time Warner (Aol) in Figure 1 illustrates how the two indicators complement each other. The Adx in the upper panel rose from April through May 2001, indicating a trending market. The Macd rose above its dotted trigger line and its zero line, showing that price direction was up. During July and August the Adx rose once again, but the Macd was then below its trigger line and its zero line, showing that a downtrend was in progress.

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