Stocks & Commodities V. 25:3 (64-67): ADX Reversal Patterns by Charles B. Schaap
When is the trend not going to continue? The average
directional movement index can provide you with information you need to differentiate between the end of a trend, a consolidation, and a reversal.
Recognizing a change of trend is important for successful trading. The earlier you can enter a new trend, the lower the risk and the greater the chance for profit. Your trading will become more effective when you can recognize the end of one trend and the beginning of another.
MEASURING TREND STRENGTH
Novice traders often make judgmental statements about a stock, statements like “The stock looks good here” or “The stock is too high and ready to tank.” What does “looking good” or “too high” mean? Instead of thinking with emotions, your first step in recognizing trend reversals should be to start observing. You should base your assessment of trend on objective data, not opinion. The best indicator for assessing trend strength is average directional movement index (ADX). ADX, which can be found on most charting programs, was developed by J. Welles Wilder Jr. In my book ADXcellence, I discuss new ADX concepts and patterns, two of which I present here.
ADX quantifies trend strength, so you don’t have to guess the strength of a trend or wonder when the trend will set up for a reversal; the ADX will tell you. The values for ADX range from zero to 100. An ADX value below 25 means trend strength is weak and can potentially retrace or reverse. Values over 25 mean the trend is strong and likely to continue.