by Stuart Evens
Thereís no way around it: Traders trade the trend, be it short
term or long term. It follows, then, that there is a need to
identify when a market is trending. Hereís J. Welles Wilderís
directional movement, a set of technical indicators designed
to recognize trending markets.
Most technical trading methods
can be categorized into one of
two types: Trend-following,
which involves taking trades
with the trend, or range trading,
which involves looking for reversal
points in a trading range.
Traders need to determine if the
stock they are trading is trending
or in a trading range. The
fact is, a system is specifically designed for a particular type
of market condition, such as trend-following, and is not
profitable when a market is in another type of market condition,
as in a range. In such cases, a trading range indicator,
such as one that indicates overbought and oversold conditions,
will put you on the wrong side of a strong trend.
Individual indicators also exhibit this characteristic.
For example, some indicators like the moving average
convergence/divergence (MACD) work well when the stock
is in a trend but then will give false signals when it is in a
trading range. Other indicators, like the stochastic oscillator,
work well when the stock trades in a range but it can give
premature overbought or oversold signals in a trending market.
Relying on indicators or trading methods in the wrong
market conditions can cause painful losses.
A way to avoid this would be to determine the type of
market that a tradable is in and then use appropriate indicators
or trading methods. With that in mind, itís not surprising that
systems have been developed to recognize when markets
shift from a trading range to trending, and then signal long
and short positions based on the indicated trend direction.
One of these systems, developed by J. Welles Wilder Jr. and
described in his book, New Concepts In Technical Trading
Systems, is known as directional movement.