CO L UMN
Figure 2: Interpretation of ADX
SOURCE: COMPOSED IN THE METASTOCK (2011) DATA BASE.
PRICE TRENDS
Accurate technical analysis is dependent upon the different trends
which prices can follow due to the
fact that various technical indicators have been developed to function more effectively in different
market conditions. This concept
was discussed in the previous article and is merely revised to serve as
background for determining specific technical indicators, given the
current market conditions. Price
trends change continuously from a
trending market to a trading market, which hamper the successful
implementation of lagging and
leading technical indicators. The
identification of the current trend
in the market is facilitated by various technical indicators specifically
developed for this purpose. The
most popular indicators include,
inter alia, Aroon and the Directional Movement Index or DMI.
AROON*
This indicator indicates a change
in the current price trend, whether
between trending and trading
markets or between an upward or
downward trend. The current type
of market is determined by evaluating the number of periods which
have expired since the most recent
high or low point reached by the
prices. The Aroon is composed by
the calculation of two different
lines, namely the Aroon Up and
the Aroon Down. The Aroon Up
measures the number of periods
since the mosts recent high point
and the Aroon Down measures the
number of periods since the most
recent low point.
The best known interpretation
of the Aroon entails the oscilation
of both Aroon Up and Aroon
Down at extreme values, which
indicates a stronger trend, and is
graphically illustrated in Figure 1.
A strong upward trend is indicated by the Aroon Up (solid line)
which moves between 70 and 100,
and the Aroon Down (dotted line)
which moves between 0 and 30, as
graphically illustrated by Area A.
The opposite is true in respect of
a strong downward trend, as illustrated by area B, where the Aroon
Down moves between 70 and 100
and the Aroon Up between 0 and
30. Should both lines move parallel to each other at more or less
the same levels, consolidation or a
trading market is experienced. The
latter is graphically illustrated by
area C.
DIRECTIONAL MOVEMENT INDEX
(DMI)*
The DMI is a unique indicator
in the sense that it diminishes the
possibility of of attempting to use
an indicator in the wrong type of
market. The DMI brings the above
about by determining the strength
of the current trend by analysing
the Average Directional Movement
Index or ADX, where the direc-
•••
tion of the trend is determined by
analysing the Minus Directional
Indicator or –DI and the Plus Directional Indicator or +DI.
The ADX line oscilates between
0 and 100, with the following interpretations:
i. An ADX value of above 25 indicates a possible trending market, as graphically illustrated by
A in Figure 2.
ii. An ADX value of below 25 indicates a possible trading market, as graphically illustrated by
B in Figure 2.
CONCLUSION
By merely having a reasonable
understanding of the above information, you will be a step ahead of
the rest. However, it will be most
beneficial to combine technical
analysis with fundamental analysis
in order to make the best possible
decision. When the longer term
support line is broken, it can usually be linked to fundamentally
changing supply and demand
factors. Determining the primary
market trend is the first step towards accurate technical analysis,
since it determines the choice of
technical indicators which are
more suitable for specific trends.
More focus will be placed on
technical indicators which are statistically more suitable for certain
market trends in future articles.
For more information
or to obtain competitive
option prices on a variety of
commodities, please contact Susari Geldenhuys at 018 464 7430
or 072 116 9999 or e-mail her at
[email protected].
* The calculation of the technical indicators
fall outside the scope of this article and are not
discussed. For further enquiries in this regard,
contact your professional and knowledgeable
Safex broker.
SENWES Scenario • Apr/May 2016
39