Sunday, April 26, 2009

ADX > 20 is a LIE

Recently i've made somewhat of a paradigm shift in how I trade (and simplified things about 10x's over) but I wanted to share a small observation I have made concerning "trending" markets and ADX readings.

First off, let me preface this by saying if you are a pure trend trader looking for MA cross overs or something into a bigger trend then this might not help you. For the rest of us going short and long based off S/R, trendlines, or Fibs then this will be relevant to you!

Ok, so we are all told from various software vendors, trading forums, trading websites, educational vendors that the GOOD trades are in trending environments correct? We are told to wait for the ADX to be > 20 to take a trade? Because then we know the market is trending right? I'm here to argue that this SIMPLY IS NOT TRUE. In fact - its the opposite.

I argue that the prime time to look for entries is in fact when the ADX <> 20 you are by definition jumping into a position after price has ALREADY MOVED A GOOD DISTANCE IN ONE DIRECTION. Thus, its probability of that trend stopping and a reversion to its mathematical mean is much much more likely which means a move against you is much much more likely as well.

Now on the other hand, by getting into a trade when the ADX <> 20. i.e. we only are looking for positions when there are green bars.

First thing to note - IF you trade like this it will be some of the easiest most carefree trading you've ever done. Why? Because ADX filters 70-90% of the price action on most days. And you sit and wait without a care in the world. I have the indicator set up to alert me when the ADX drops below 20 so I get a message saying pay attention and then we look for trades. This will DRASTICALLY reduce trade amounts, increase efficiency, reduce commissions, and eliminate the possibility of overtrading a market. Lets face it folks - most of us aren't good enough to be 100% on every swing 100% of the day. It gets us into trouble and we all know it. So why fight it? Especially if you can filter 70-90% of the day and only focus on tiny points on the chart where the probability for a trend developing is in your favor?

I apologize for the size of these charts but nothing peeve's me more than someone posting a chart example thats too small to see. You should have no issues here.

These examples will be nothing more than trendline breaks snapped to a Pivot High/Low reading on the charts. Entries on breaks of the trendlines with the ADX < 20. NOTHING ELSE. You decide the management and targets but it would be pretty hard to lose money here.

You are jumping in at the momentum shift BEFORE THE TREND OCCURS.

Now take a look at the entries where the ADX > 20 and the pundits would like to tell us its a GREAT TIME TO LOOK FOR TRADES. Almost everything loses.

Coincidence? That's for you to decide. I don't think it is coincidence. In fact this is exactly how I trade from here. ADX and trendlines. Call it a day and make money. Only we can complicate the hell out of it "looking for the trend". The truth is the trend is relative, and thus WE DEFINE IT. And if that's the case, everyone else has a difference definition and no one can be right or wrong. So why bother? Swing your middle finger up at the "trend" and forget about chasing it. Its a fruitless effort and a lie, and one that hasn't made too many of us rich.

Think its a fluke? Go look at it yourself. These examples were in Forex but the same technique applies directly to the emini's!

ADX and trendlines. The only tools you need to make yourself rich.



Richard said...

Well, since all of your entries are counter to the original trend (you play trendline BREAKS, after all), of course you don't want a strong trend (adx >20) to be in effect when you take them. It's just common sense. When people advise taking trades with high ADX values, I'm fairly certain they mean trades WITH the trend. You know?

Anonymous said...

Indicators - ALL indicators - will show you the past and nothing but.

You done some backtesting, come up with some true numbers like from the past five years or so?

Those with unlimited resources have tested any possible indicator long before we even existed. An ADX or MACD or RSI or abnything alike, is not what pro-traders use.

trailingstoptrader said...

During market hour, the ADX need to achieve >20, not necessarily all the time must be > 20. I have observe that the ADX reading may dip to 17 MOMENTARILY before resuming > 20, and the price action is good after that.

Some days the ADX is already >40 but no price action, so downward direction of ADX will indicate less priceaction.

Eventhough ADX is not a perfect indicator, it is very useful.

Michael said...

I've always thought the ADX is totally useless, by the time it tells you the trend is strong, the trends nearing it end, then when the trend does turn, again, by the time it tells you the new trend is strong it's about to reverse again or in many cases it's already trending the other way.

Before criticizing Matt because he's going against conventional wisdom, take a moment and check out what he's talking about, he is on to something.

Don't be so quick to dismiss his theory, you may be surprised at what you'll find. I certainly was!

Matt said...

Thanks for the comments gents. As I mentioned, if your method is a trend following method than by all means this won't help you. But if you look for breakouts and reversals then this might be something to take a look at.

Good Trading!