An Indicator For You To Use
A few weeks ago, in a mid-week analysis I did on the
market, I mentioned that we were very close to a large move in the market. How
did I know that this was going to happen? Well, I wish I had the clairvoyance to
perfectly predict these things (and also the ability to pick the winner of the
NCAA basketball tournament) but I don't. What I have is an indicator which I'll
share with you to use in your future trading.
Predicting A Large Move
Markets go from being quiet, as they were for the past few
months, to explosive, as they were this past week. This phenomenon occurs year
after year, and decade after decade. If you look back into 2002, you'll see a
very quiet market in the first few months of the year. Volatility was drying up
and the press was quoting Wall Street professionals as saying there was a
structural change in the market and that this type of low volatility could
possibly last for years. Well, they were a bit over in their time prediction. It
lasted about a few more weeks before the market went into a volatile downward
spiral heading into the summer.
Now, let's move a year ahead and look at the market last
year. An explosive move to the upside beginning in March which lasted for a
while. And then, the market's volatility kept getting lower and lower. In fact,
for the past few months, most of us have been bitching and complaining about the
lack of volatility and lack of meaningful moves. And then, boom! This week the
market explodes.
How can you know when this type of move is going to
happen? There are a number of ways. Over the past decade I've published research
on how to predict volatility (some of it can be found in my books and also in
the University Section of TradingMarkets.com). Today I'll share with you a way
that you may not have seen before and it's the indicator I relied upon a few
weeks ago to make the comment that a big move was near.
The ADX 20 Explosion Indicator
One of the ways to predict if a big move is near is to use
ADX. For those of you who are new to the indicator, ADX is the Average
Directional Indicator. It measures the strength of the trend. When the trend is
strong, ADX is high. When the trend is non-existent (meaning low volatility) ADX
gets to low levels. We use a 10-period ADX in order to make our decisions (most
charting packages default to 14 so you'll have to manually make the change). We
use a 10-period ADX instead of a 14-period because we believe the 14-period lags
too much and the 10-period helps us gauge the market on a shorter-term basis.
The time to start paying attention to a possible big move
is when the 10-period ADX gets under 20. This usually happens about 3-4 times a
year and it tells you that volatility has dried up. Does a reading under 20 mean
that it's automatic and the market is going to explode immediately? Absolutely
not! In fact, one could argue that you should stay out of the market when
the ADX is under 20 because things are dead and that it will be tough on a
day-to-day basis to make money until the big move begins. But, once the move
does begin, it's sometimes very big. And this past week is a good example.
Another time period you can look at in order to better
learn about this timing indicator for your trading? Look at this past November.
The reading got down to as low as 16.81. A month later the market was 5% higher.
And as I mentioned earlier, this happens about 3-4 times most years.
How Can You Trade This?
Many ways and too numerous to list in one article. But,
you can take some of the
research I posted here over the past few months on market entry and combine
them with today's research. You can also look at various breakout strategies
that are published throughout the web including the TradingMarkets site. Having
multiple strategies and indicators saying the same thing at the same time will
potentially improve your chances of success. And, if history plays itself out in
the future, you should get an opportunity to use the ADX 20 Explosion Indicator
again sometime this summer.
Have a great week trading (and if you any questions,
please feel free to send them to me)!
Larry Connors
