TRADING TECHNIQUES
How Do You Find The Moment A Trend Begins?
Trend-Following With The ADX
by Martin Boot
Have you ever been interested in a system, but weren't quite sure how it worked? Here's a simple and robust trend-following system using the ADX, with only one entry condition and one exit condition. Because it's simple, the user always knows exactly what the system is doing.
To design and develop a sound trading system, we need a clear and logical basic idea. From this, we must derive proposed entry and exit points. A sound trading system must be robust; for the system to be as robust as possible, the idea must be as simple as possible. A robust system is one that behaves consistently in different markets; a robust system should not need constant adjustments for any new market to which it is applied. I kept these criteria in mind when I decided to develop a trend-following system.
FIGURE 1: AMSTERDAM EXCHANGE INDEX. Checking a simple use of ADX (go long above 20) on the AEX gave six wins out of six.
DOES THE ADX WORK?
One of the problems with trend-following systems is finding out when the trend begins to develop. How do you find the moment a trend begins? The average directional movement index (ADX), developed by J. Welles Wilder, measures the strength of the prevailing market trend as well as whether there is market movement. ADX does not pick direction; rather, it indicates whether and by how much the market is trending. But does it work?
This train of thought brought me to these conclusions:
1. The beginning of the trend
If ADX can determine whether a market is trending, there should be a starting point to the trend. It would not be logical if ADX would not signal that point.2. The end of the trend
If ADX can determine the strength of a trend, there should be points of acceleration and retardation of this trend. It would be illogical if ADX would not signal these points. If the point of the slowdown can be determined, this could be used as the exit point for the system.3. Direction
If ADX cannot determine whether the trend is up or down, we should be able to use other means to find out the strength of the trend.4. ADX measuring the strength of a trend
For an ADX-based system to be profitable, it should be applied to markets with considerable moves while in a trend.
Martin Boot is a computational linguist, a psychotherapist, and a writer, but at the moment, he is a full-time trader. He can be reached via E-mail at: 106510.2575@compuserve.com.
Excerpted from an article originally published in the September 2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2000, Technical Analysis, Inc.
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