V.11:4 (149-155): Filtering Breakouts by Adam White

V.11:4 (149-155): Filtering Breakouts by Adam White
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Filtering Breakouts by Adam White

Which is more effective as a signal filter, the average directional movement index (A DX), the indicator developed by J. Welles Wilder to measure market trend intensity, or the unsmoothed version, the directional index (DX)? Adam White of the Technical Traders Bulletin measures the performance of a breakout trading system using the ADX or the DX as signal filters.

In hindsight, few things look better on a chart than a successful breakout a profitable move to a better price signaled by the crossing of an established support or resistance level. But for every successful breakout there are several that fail. There are many ways that a trader can try to tip the strategic odds of trading breakouts in their favor; here, I will look at a method involving ADX and its cousin, DX . I will also share a technique aimed at reducing some deleterious aspects of optimization, a technique I call universalization.

STANDARD BREAKOUT

Most traders are familiar with traditional breakouts as a means by which to enter a trending market. Considering moves to the upside only, a breakout can be mechanically recognized as making an n-bar high, assuring that the market has risen above the resistance level that previously kept it in the trading range. A breakout can be a sign that the fundamental market outlook has changed from a balance of bullish and bearish forces to a scenario in which the bulls prevail (see Figure 1).

A second, and more subtle, tug of war is also going on for market psychology, and that is whether participants expect the market to be primarily a trading range market or an openly trending market. On some level, market participants make some of their decisions about expected future price movement by referring to past movement. But what aspect of past movement are participants focusing on, the turning points or the trends? When the focus on the turning points dominates the focus on the trends, the market is more likely to stay in a trading range than it is to move to new territory.




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