V.17:2 (87-94): Directional Movement by Stuart Evens

V.17:2 (87-94): Directional Movement by Stuart Evens
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Directional Movement

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.

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