Melody ADX
The Traditional Understanding
J. Welles Wilder developed the Average Directional Index (ADX) to evaluate the strength of a current trend, be it up or down. It's important to determine whether the market is trending or consolidating (moving sideways) in order to access risk/reward properly.
The ADX is an oscillator that fluctuates between 0 and 100. Readings above 60 are relatively rare and can often indicate overdone conditions. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. The indicator is not directional, but merely assesses the strength of the current direction or trend. A reading above 40 can indicate a strong downtrend as well as a strong uptrend.
ADX can also be used to identify potential changes in a market from trending to consolidation. When ADX begins to strengthen from below 20 and moves above 20, it is a sign that the trading range is ending and a trend is developing.
The typical ADX indicator consists of three lines. The ADX line (Black) which signals the strength of the move. In addition there are two other lines on the chart, +DI and –DI (the DI part stands for Directional Indicator). The +DI indicates bullish moves, while the –DI indicates bearish moves.
The ADX indicator does not give buy or sell signals. It does, however, give you some perspective on the “remaining life” of the trend. Low readings and you have a trading range or the beginning of a trend. Extremely high readings tell you that the trend will likely come to an end.
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Our Interpretation
We have slightly changed the ADX into a form that is more useful for Bob’s style of trading. Bob’s experience has taught him that the best use of the ADX, is in getting out of profitable trades early and potentially re-establishing the trade at a better level, as well as exiting losing trades at a smaller loss than a previously placed stop when a trend is changing quickly. This requires a much easier-to-read ADX, which is what we’ve created. Bob pays close attention to the tone or “Melody” of the markets, which is what drives momentum and trends. Our custom indicator helps identify when these trend breakouts begin in a clearer manner than a traditional ADX. Instead of using a set of lines, we felt that a series of colored bars would truly stop from seeing false breakouts. We also slightly re-engineered the inputs to capture trend changes earlier than a traditional ADX. By being able to see a set of bullish or bearish bars increasing, one will be able to capture the trend faster and earlier in the trends move.
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