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Catch that Trend! Directional Strength and How to Find it.

Contributed by Barbara Star, Ph.D.

Traders usually favor moving averages to help them determine price trend. However two other popular indicators, the Moving Average Convergence/Divergence (MACD) and the Average Directional Index (ADX), can help traders detect not only trend direction, but trend strength as well.
The MACD, created by Gerald Appel, is a momentum indicator that often identifies price direction as it rises and falls above or below its trigger line and its zero line.
The ADX, part of the Directional Movement system developed by Wells Wilder, is designed to detect the strength of price movement. ADX values in the 20 to 30 range indicate mild to moderate trending behavior while values above 30 usually signify a strong trend. A rising ADX indicates that prices are trending, but does not reveal the direction of that trend.
Plot the ADX 14 period indicator above the MACD on the same price chart as shown in Figure 1, and patterns emerge that show both trend strength and trend direction.


Three Patterns
Three distinct, and profitable, patterns frequently appear. These patterns do not detect tops and bottoms, but can help traders confirm a trend. They are especially useful for those traders who prefer shorter-term trades.
Confirming Pattern: The confirming pattern occurs when both the ADX and the MACD rise and fall in unison with price. When the indicators rise together they identify up-trending price movement that presents bullish traders with an opportunity to enter the long side of the trade. The strongest and most ideal trading configuration takes place when the ADX begins to rise and the MACD rises above its trigger line and also above its zero line. The level from which the ADX rises does not matter. In the Confirming pattern, when prices change direction to the downside so do both the ADX and MACD to indicate a loss of momentum and/or a potential trend change.
The Confirming pattern was evident on the daily Allegheny Technology price chart. Both indicators rose in April confirming the price move from the $30 to $40 level. Both indicators declined in May as prices dipped, but rose once more in June when price moved toward $45. The indicators declined in late June to reflect the falling to sideways price action.


Diverging Pattern: The diverging pattern identifies down-trending price movement. Here, the indicators move in opposite directions. The ADX rises to indicate that it has found a trend, but the MACD declines which indicates that the direction of the developing trend is down. Its mirror-image formation makes it an easy pattern to spot visually.
This is a good pattern to follow for traders who are bearish and want to short a stock. It also serves to warn those traders who might wish to enter a long position that they should wait for a more favorable time.

The strongest pattern occurs when the ADX rises while the MACD falls below its trigger line and also below its zero line. Two distinct Diverging patterns appeared on the chart of Abbott Labs in Figure 3 as prices took a nosedive from February to March and again in April.



Converging Pattern: This pattern has an upward bias that comes after a steep decline. The ADX rolls over and begins to decline, signifying that the strength of the trend has weakened. At the same time the MACD, which had been below its zero line, begins heading up to its zero line. Visually, the declining ADX and the rising MACD seem to be converging toward each other. Although this pattern sometimes marks the beginning of a new up trend, more often than not it is a countertrend rally that produces a partial retracement of the price decline.
Figure 4 shows the Converging pattern on a daily chart of Honeywell International. Following the price decline in the February time period that took the stock below the $25 level, price began moving up in March where it was able to retrace much of its loss. The MACD responded to the increase in price by crossing above its trigger line and rising to (and in this case, through) its zero line as the ADX stopped rising and moved down to complete the Converging pattern.
This is an enticing pattern, but often not as profitable as the others because its moves tend to be short-lived and, even though the MACD rises, prices may move sideways instead of upward.


A Trading Example

Traders could have profited from many of the patterns signaled by the ADX-MACD duo on the CH Robinson Worldwide price chart in Figure 5.
Area A marked a decline with a Diverging pattern that was followed by a Converging pattern as price rose in area B. That Converging pattern gave way to a Confirming pattern (Area C) as price continued to rally another ten points. A new Confirming pattern appeared in Area D which reflected the decline that filled a prior price gap before reversing to the upside.
Could you have benefited from any of the four areas identified by the ADX-MACD patterns?



Summary

The patterns displayed by the ADX and MACD combination appear on charts of commodities, indexes, and mutual funds as well as stocks. Not only do the patterns have profit potential, they signal changes in price which can help avoid trading pitfalls. This dynamic duo may be worth adding to your trading arsenal.

About Barbara Star
Barbara Star, Ph.D., (818) 224-4070, is a former vice-president of the Market Analysts of Southern California. She is a frequent contributor to the magazine, Technical of Stocks and Commodities. A former university professor, Dr. Star currently provides individual instruction and consultation to those interested in learning technical . Her e-mail address is star4070@aol.com

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Support Tip

How to Automatically Load Your MetaStock Charts at Start-up

Contributed by Equis Support

Any trader can tell you that being able to quickly load your workspace makes decision making easier and faster. With the ever changing markets, seconds can mean the difference between making a profit and taking a loss. MetaStock's "Restore workspace on startup" allows users to automatically load a user defined workspace of charts and trading systems when opening MetaStock.

How do I get MetaStock to automatically open my charts?

1. Open MetaStock
2. Select - Tools - Options
3. Select the General tab - check the option "Restore workspace on startup".
4. Click OK to apply the settings.
5. Next open all the charts you would like to open automatically on startup, then select File - Exit to close the MetaStock program.
6. When you re-open the program it will open those charts.

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MetaStock Features

JBL Risk Manager v7.0

Contributed by Devin Ekberg

As I interview successful traders from all over the world, I have the fortune of learning what works and what doesn't work. Overwhelmingly, successful traders share common principles in their individual strategies even though they trade and invest in different markets around the world. Simply stated, there are four requirements:

Entry Strategy - Education & Experience
Trade Sizing Strategy - Money Management - How many shares to buy.
Exit Strategy - Risk Management - Minimize Loss with a stops or exits.
Profit Taking Strategy - Protecting Profits on the way up, when do I SELL

Unfortunately, the major focus of many technical traders is to create a system of entry and exit rules, and trying to develop discipline to follow them. However, they ignore the critical concept of money risk management, and endanger their long-term survival.

There are many books available on proper risk and trade management, and learning these principles are important for removing emotion and calculating risks. The subject is sometimes a bit difficult to follow and ultimately difficult to put into practice.

The new JBL Risk Manager v7 software from Metastock gives a simple "step-by-step" method of managing your trades. It gives you Automatic Trade/Position Sizing, Initial Stop and Trailing Stop exit price calculations, Multiple Portfolios, Short & Long trades, integrates with your Metastock database, Stock Split Adjustment, Performance: Win/Loss ratios, and Trade Expectancy.

This add-on is very unique among the Metastock add-on and plug-in library. If you are currently trading and not utilizing a money management tool, I strongly encourage you to add this to your to-do list. It will make a huge difference.