When traders, investors and technical analysts gain experience they find that there is only one question that needs to be answered and that is: “Is It Trending Or Sideways Market”? They learn that if they find the right answer, all of their analysis and trading systems will start performing at the best.
Why Is It So Important To Identify Trending Or Sideways Market?
So simple in trading, all the money is made or lost because of difference in price. Only in trending market, there is any considerable difference in price happens.
That is the reason, most of the trading system and methods are trend following in nature. It may be dow theory, moving average crossover, MACD, pattern breakouts, heikin ashi, renko, PHPL, NHNL and the list is infinite!!!
But when the market is only moving sideway without any considerable move in any direction. All trend following systems, methods and techniques fail and give false signals. The following chart explains the same.
So as seen in above chart there are frequent signals by MACD and most of them are false when the market is sideways. While there are only two signal in trending market and are profitable. The same is the story with all of the trend following signals. Now let’s move to the solution.
How To Decide Trending Or Sideways Market?
Most of the traders have not any idea about how to filter signals in the sideway market and trending market. Traders get frustrated when they find their favorite system that was working for some period very accurately is not working and giving false signals in the sideways market. They are constantly making losses on every signal, waiting for one big profitable signal.
ADX Indicator Filtering The False Signals
There can be many solutions in terms of skill and experience of the technical trader. But today I will give you most widely popular and simple solution for deciding if the market is trending or trading. The best simplest indicator used for deciding trending market is ADX, in full form it is “average directional movement”. So this indicator checks if the price is moving sideway or in the vertical direction.
We will discuss the calculation of ADX indicator later. We will learn more about how to use ADX indicator for filtering false signals from any trading system. The standard period used for ADX is 14 day for the daily chart so we will continue our discussion with this value. Traditionally there are three lines in ADX indicator which are ADX line, +DI line and -DI line. But here I will discuss only ADX line which is useful for finding if the market is trending or trading.
How To Use ADX Indicator
The value of ADX indicator generally varies between 5 to 75 for stocks, depending upon the value of indicator and whether it is rising or declining we can say what is the technical condition of particular stock at that time, is it sideways, trending or strong trending and accordingly use other technical system to trade the stock efficiently.
In the above chart when the color of ADX line is yellow it indicates rising value. When the value of ADX indicator is declining, white color is used. The three red line indicates ADX level of 20, 40 and 60 respectively from the bottom.
Now let’s understand ADX value to define the market stages in the following slide.
When ADX value is below 20 it indicates sideways market. If ADX cross 20 level from below it is the start of a new trend either in up or down direction. When the trend in the stock matures, the ADX value reaches above 40 level and keep rising. In this area, the trends are very strong and it can take ADX value above 60. If ADX reaches beyond 60, this trend is now at the climax. When finally the ADX value reaches its peak and starts declining, still the stock is under trend until the ADX value is above 40. Below 40, if ADX is declining then also it is considered sideways or non-trending market. This way we can differentiate between sideways or trending market with ADX value and its direction.
Now with this tool try to understand the trading with magical trend indicator in the top most image. In chart watch how ADX indicator remains above 40 for most of the time and at the best above 20. This trend gave a large profitable trade from magical trend indicator. For more example and more understanding please watch the following supplementary video tutorial.
How To Use ADX In Forex Market Or For Stock Market Indices
The value of ADX depends upon the movement of underlying and period used. The level of ADX in the above paragraph like 20, 40 and 60 are specifically for stocks and that is also for ADX(14). For market indices like Nifty 50, Dow Jones, FTSE, S&P 500 etc. the movement will be lesser compared to stocks. So for indices, the benchmark level will reduce. For deciding what exact level to use we should observe historical charts. The same can happen with forex charts. You should watch past chart to decide optimum level for deciding start of trend, strong trend and trend climax. There is still one more useful indicator for defining trending or sideways market. That we will discuss in near future.
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