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FRED GOODMAN'S KEY INDICATORS FOR
INVESTMENT SUCCESS
Since the 70's, Welles Wilder has developed a great number of very useful indicators, including the Relative Strength Indicator (RSI). An important one to traders is the Average Directional Movement Index, referred to as ADX. It is used to determine if a price series is in a trend or a trading range. Wilder's indicators were originally developed for commodities trading, but they serve well for stocks and market averages as well.
Suffice it to say that the ADX is determined from measurements of the direction of the market over continuous periods of 14 days using the high, the low and the close of each pair of adjacent days. When the market is making big daily changes the ADX increases, and when they are making small changes the lines drop, just as they have since late June. It does not matter whether the market is going up or going down, the indicator simply shows that it is in a trend or in a trading range. When the lines are above 25% the market is considered to be trending, when they are below 25% it is considered to be in a trading range. It has long been observed that momentum indicators, such as moving averages, for example, work best when the market is trending.
The next chart illustrates Wilder's Directional Movement Indicators (DMI) in red and green. Not only are they used to determine when the market is likely to rise or fall, but they are used in the calculation of the ADX itself. Since the ADX (blue line) shows only when the market is in a trend, but says nothing about whether the trend is up or down, the DMI indicators are used to determine the direction your trade should take. If the green line is above the red, you buy, and if the red line is above the green, you sell. However, one only pays attention to the red and the green when the ADX is above 25%. Pring presents an interpretation of the system that is somewhat different from that of the inventor, and assures us that there are many different interpretations that can be used with good results. Pring points out that some of the best trades have been opened when the ADX was still below 25% -- but advancing -- when one of the two DMI lines moved above the other. The application of the DMI's and the ADX to the S&P, Dow and NASDAQ, are telling us very clearly that we are in a trading range and must have patience before getting fully invested.
Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages. There is no guarantee that you will profit from trading as discussed herein. You may lose money and Fred assumes no responsibility for what you do or do not do with this information. 
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