In Jack Schwager’s famous interviews of the ‘Market Wizards’ he compiled a list of the ten criteria that are present in all successful traders. Amongst that list was one which I believe to be the most glaringly difficult to master, that of patience. Sinan Koray and his excellent pieces on trading psychology will be the most expert individual to help you come to terms with and master the art of waiting, however, there are some very simple technical indicators that you can employ to decide whether or not now is a good time to be trading a given share, index or future.
The basis for most trading methodologies is to focus on trend analysis. Clichés such as “the trend is your friend” are rife in market lore and there are many good reasons for this. Whether you trade Gann’s mechanical trading system or derivations thereof, or whether you focus on Elliott Wave Four trades, you will notice that the most success comes from identifying a trend and taking the appropriate action.
The method of trading which has yielded some of the best results for Elliott traders is to employ a top down approach. First, a sector of the economy is identified as trending particularly well. Second, an Elliott Wave 4 scan is applied across the companies within that sector and then, after confirmation, a trade is taken. The question always remains, however – which sector is trending strongly?
It is possible to simply look at the charts of the different sectors in order to confirm which ones are trending and use subjective techniques to determine the trend. Although this is not ideal or measured it can offer a quick fix solution. A more technical approach may be to use a moving average oscillator and compare the areas of maximum oscillator divergence to see if one sector is rapidly accelerating in trend compared to another. ProfitSource users may even employ more complex and accurate methods such as the ‘Relative Strength Comparison’ (RSC) tool in order to parameterise outperformance.
An indicator that has been devised specifically to measure and quantify an instrument’s trendiness (for want of a better word!) is the DMI. The DMI is a momentum indicator that is constructed through various calculations that result in 3 lines: a DI+, a DI- and an ADX. Although originally intended to support an entire trading system with long and short signals, for a trader using Elliott Wave or Gann analysis to pick entry points, the DMI’s ‘ADX’ might well be the most useful component.
The ADX is designed to show the overall strength of a trend, regardless of direction. Typically, an ADX greater than 40 represents a trending market and any reading less than that shows the market to have no real direction. Within ProfitSource’s help function it is suggested that an ADX below 20 that moves above 20 is showing signs of a trend developing.
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As you can see in the image above, several sectors have been charted and are all displayed with their respective ADX readings shown beneath. The blue horizontal line is merely an ADX marker set at 25. According to the ADX, not one of these markets is currently trending and by default, for Gann and Elliott players using a top down approach in combination with trending techniques, there are no reasons to be in any of these markets. It’s a great time to hurry up and wait, a good time to practice patience.