concept of directional movement

1. Moving Averages

2. Moving
Averages
Section I – 39%
Concept of Moving Averages
 Types of Moving Averages
 Length of Moving Averages
 Strategies using Moving Averages
 Concept of Directional Movement
 Envelopes
 Channels
 Bands

3. Concept
of
Directional Movement

4. Concept of Directional Movement
• Concept of trend and direction is the concept of directional movement that
Welles Wilder (1978) developed in his book New Concepts in Technical Trading
Systems.
• Wilder compared a stock's trading range for one day with the trading range on
the previous day to measure trend.
• Positive directional movement occurred when the high for a day exceeded the
high of the previous day.
• The amount of positive directional movement (+DM) is the day's high minus
the previous day's high, or the vertical distance between the top of the two
bars.
• If the low for the day is less than the previous day's low, negative directional
movement occurs. The value of the negative directional movement (—DM) is
the difference between the two lows.

5. Concept of Directional Movement

6. Constructing Directional Movement Indicators
• A moving average is calculated for both +DM and —DM, usually over 14 days,
using the Wilder method of averaging.
• In addition, a 14-day average trading range (ATR) is calculated. Two indicators
are calculated using this data.
• The positive directional movement indicator (DI+) is the ratio between the
smoothed +DM and the TR; this calculation gives the percentage of the true
range that was above equilibrium for those 14 days.
• The second indicator is the negative directional movement indicator (DI—),
which is calculated as the ratio between the smoothed —DM and the ATR.

7. Average True Range (ATR)
• Average True Range (ATR) is an indicator that measures volatility.
• A volatility formula based only on the high-low range would fail to capture
volatility from gap or limit moves.
• Wilder created Average True Range to capture this “missing” volatility.
• It is important to remember that ATR does not provide an indication of price
direction, just volatility.
• Wilder designed ATR with commodities and daily prices in mind. Commodities
are frequently more volatile than stocks.

8. True Range (ATR)
• Wilder started with a concept called True Range (TR), which is defined as the
greatest of the following:
Method 1: Current High less the current Low
Method 2: Current High less the previous Close (absolute value)
Method 3: Current Low less the previous Close (absolute value)
• Absolute values are used to ensure positive numbers. After all, Wilder was
interested in measuring the distance between two points, not the direction.
• If the current period's high is above the prior period's high and the low is
below the prior period's low, then the current period's high-low range will be
used as the True Range.
• Methods 2 and 3 are used when there is a gap or an inside day (Directional
Movement)

9. True Range (ATR)
• Example A: A small high/low range formed
after a gap up. The TR equals the absolute
value of the difference between the current
high and the previous close.
• Example B: A small high/low range formed
after a gap down. The TR equals the
absolute value of the difference between
the current low and the previous close.
• Example C: Even though the current close is
within the previous high/low range, the
current high/low range is quite small. In
fact, it is smaller than the absolute value of
the difference between the current high
and the previous close, which is used to
value the TR.

10. Calculation of ATR
• Average True Range (ATR) is based on 14
periods and can be calculated on an intraday,
daily, weekly or monthly basis.
• the first TR value is simply the High minus
the Low, and the first 14-day ATR is the
average of the daily TR values for the last 14
days.
• IN the excel sheet first True Range value (.91)
equals the High minus the Low (yellow cells).
The first 14-day ATR value (.56)) was
calculated by finding the average of the first
14 True Range values (blue cell). Subsequent
ATR values were smoothed using the formula
above.

11. Average True Range

12. Conclusion ATR
• ATR is not a directional indicator, such as MACD or RSI.
• ATR is a unique volatility indicator that reflects the degree of interest or
disinterest in a move.
• Strong moves, in either direction, are often accompanied by large ranges, or
large True Ranges. This is especially true at the beginning of a move.
• ATR can be used to validate the enthusiasm behind a move or breakout.
• A bullish reversal with an increase in ATR would show strong buying pressure
and reinforce the reversal.
• A bearish support break with an increase in ATR would show strong selling
pressure and reinforce the support break.
• Calculate back at least 250 periods (typically much further), to ensure a much
greater degree of accuracy for our ATR values.

13. Directional Movement Indicators (ADX)
• The Average Directional Index (ADX), Minus Directional Indicator (-DI) and
Plus Directional Indicator (+DI) represent a group of directional movement
indicators that form a trading system developed by Welles Wilder.
• Positive and negative directional movement form the backbone of the
Directional Movement System.
• Wilder determined directional movement by comparing the difference
between two consecutive lows with the difference between their respective
highs.
• The Plus Directional Indicator (+DI) and Minus Directional Indicator (-DI) are
derived from smoothed averages of these differences, and measure trend
direction over time.

14. Directional Movement Indicators (ADX)
• These two indicators are often referred to collectively as the Directional
Movement Indicator (DMI).
• The Average Directional Index (ADX) is in turn derived from the smoothed
averages of the difference between +DI and -DI, and measures the strength of
the trend (regardless of direction) over time.
• Using these three indicators together, chartists can determine both the
direction and strength of the trend.

15. Calculation (ADX)
• Directional movement is positive (plus)
when the current high minus the prior
high is greater than the prior low minus
the current low. This so-called Plus
Directional Movement (+DM) then
equals the current high minus the prior
high, provided it is positive. A negative
value would simply be entered as zero.
• Directional movement is negative
(minus) when the prior low minus the
current low is greater than the current
high minus the prior high. This so-called
Minus Directional Movement (-DM)
equals the prior low minus the current
low, provided it is positive. A negative
value would simply be entered as zero.

16. Calculation (ADX)
• Calculate the True Range (TR), Plus Directional Movement (+DM) and Minus Directional Movement
(-DM) for each period.
• Divide the 14-day smoothed Plus Directional Movement (+DM) by the 14-day smoothed True Range
to find the 14-day Plus Directional Indicator (+DI14). Multiply by 100 to move the decimal point two
places. This +DI14 is the green Plus Directional Indicator line (+DI) that is plotted along with the ADX
line.
• Divide the 14-day smoothed Minus Directional Movement (-DM) by the 14-day smoothed True Range
to find the 14-day Minus Directional Indicator (-DI14). Multiply by 100 to move the decimal point two
places. This -DI14 is the red Minus Directional Indicator line (-DI) that is plotted along with the ADX line.
• The Directional Movement Index (DX) equals the absolute value of +DI14 less -DI14 divided by the
sum of +DI14 and -DI14. Multiply the result by 100 to move the decimal point over two places.
• After all these steps, it is time to calculate the Average Directional Index (ADX) line. The first ADX
value is simply a 14-day average of DX. Subsequent ADX values are smoothed by multiplying the
previous 14-day ADX value by 13, adding the most recent DX value, and dividing this total by 14.

17. Calculation (ADX)

18. • The Average Directional Index (ADX) is used to measure the strength or
weakness of a trend, not the actual direction.
• Directional movement is defined by +DI and -DI. In general, the bulls have the
edge when +DI is greater than -DI, while the bears have the edge when -DI is
greater.
• Crosses of these directional indicators can be combined with ADX for a
complete trading system.
• Stocks have price characteristics similar to commodities, which tend to be
more volatile with short and strong trends.
• Stocks with low volatility may not generate signals based on Wilder's
parameters.
Interpretation (ADX)

19. • Average Directional Index (ADX) can be used to determine if a security is
trending or not.
• This determination helps traders choose between a trend-following system or
a non-trend-following system.
• Wilder suggests that a strong trend is present when ADX is above 25 to 40.
• No trend is present when below 20.
• Exhaust of trend above 40 .
• ADX at Zero means market at its peak consolidation time.
Interpretation (ADX)

20. Interpretation (ADX)

21. Interpretation (ADX)