Bulletin 5 Adx Has It's Limitations

The Traderclub Forum: Traders Club Bulletins: Bulletin 5 Adx Has It's Limitations

David Elden (Admin) on Thursday, February 11, 1999 - 11:00 pm:

Chuck LeBeau's System Traders Club
Vol. 1 Number 5 Sept. 24, 1998

Table Of Contents:
Free Classifieds Announcement
Comment by Chuck: CNBC Features System Traders
Serendipity Bond System Announcement
Traders Toolkit: Adx Has It's Limitations:
Chuck Appearing in Raleigh NC.


Our website has been up and running for a while and there has been lots of traffic.(2,000 - 10,000 hits a day) We have tried to post some useful information and make the site as user friendly as possible. The HOME page and the FORUM page are getting the most interest.


One of our members suggested we have a classified ad section on the web site and we think this is a great idea. Brokers and vendors would have to pay for their ads but individuals and non-profit entities would be able to post their ads for free. For example if someone had used books or courses on trading that they wanted to sell. Or perhaps someone wants to buy or sell a used copy of SuperCharts. We could even do some job listings. Lots of possibilities. The classifieds will be found at http://traderclub.com/Classifieds.htm Make web history and be the first to post a classified ad on our site.


As I'm writing this paragraph I'm listening to CNBC on my TV and they are doing a special feature on systems traders. The good news is that the CNBC coverage is very favorable but the bad news is that it is really dumb. I'm surprised at how little they know about systems trading. For example they imply that systems traders are out surfing (now showing video footage of teenagers surfing) while their high powered main frame computers run "high tech moving average systems" to trade the markets. I'm laughing out loud here. Wish it were that easy! I'm really surprised that they think you need a main frame computer to do moving averages. Shows you how uninformed they are. Fortunately they did imply that systems traders as a group fared very well recently (not sure where they got that info) while other investors were losing big money. At least their coverage put a very favorable spin on systematic trading. Maybe it will help generate more interest in our web site so we can help educate the public as to what systems trading is really all about.


In the past we've been trying to mail out a Bulletin about once every two months. Now that we can distribute our Bulletins so easily via email we've decided that we should be doing the Bulletins more frequently. (This electronic publishing is wonderful.) Lots of what used to be in the Bulletins is now available live on our web site so the Bulletins will usually be shorter now.


Due to the upward bias in our historical bond data we were beginning to think the short side was impossible. Fortunately we were persistent and after months of trying and many wastebaskets full of lousy test results we finally figured it out. Not surprisingly the breakthrough was in finding the proper exits and the resulting system is quite simple (the best kind). We named the system SERENDIPITY because we set out to create a short side system and also discovered an excellent long side system in the process. We think the Serendipity system will be able to trade both sides very nicely. You can find the performance details on the web site at http://traderclub.com/systems_serendipity.htm


(I'm referring to Welles Wilders Average Directional Index in case you are a "newbie".) After many years of extolling the virtues of the ADX in articles and lectures all over the world I have become closely associated with this indicator. That's fine with me and I don't mind being considered the resident expert on ADX. It is an excellent measure of trendiness and a good indicator to be linked with.

However, I think it is a mistake to try and over work or become too dependent on any one indicator. If you were going to build a house you would need more than one tool and you wouldn't try to do it with just a hammer. The same is true of building systems. The ADX can be a very valuable tool if used correctly but it has some major shortcomings that everyone should be aware of: We all know that the ADX is slow. This is because of all the smoothing in the formula. The basic ingredients are smoothed and then the results are smoothed again. For example I think it takes more than 30 bars of data to calculate a 14 bar ADX. This smoothing makes the ADX slow but there is an even greater problem than just the speed of the indicator. The logic of measuring directional movement makes the ADX very reliable at certain times and very unreliable at other times.

A rising ADX is a reliable indication of a trend when there has been an extended sideways period before the trend gets started. Before all the high tech computer mumbo jumbo we used to simply refer to this sideways period as a "basing pattern". The ADX is most effective when it begins to rise from a low level (low = 15 or less). This low level on the ADX indicates that there has been a basing pattern for a while. This interpretation is contradictory to those users of the ADX who want to see the ADX cross above a specified threshold (usually 20 or 25) to indicate that a trend is underway. This technique would make the ADX even slower and means you would be confirming a trend and entering your trade long after the basing pattern was broken. But even if you were late due to your method of interpreting the ADX, following the ADX after a base pattern is still quite reliable. The potential problem I want to bring to your attention in this article is the action of the ADX after major peaks and valleys.

The logic of the ADX is best visualized as measuring directional movement over a moving window of data on a bar chart. If we have sideways data in the window followed by recent trending data (lets think of rising prices but it could be the reverse), the rising prices would show directional movement relative to the sideways data at the beginning of our window. The ADX would promptly rise and call our attention to the fact that there is now a direction in prices that should continue for a while.

However, if the prices rise for an extended period and then begin to fall sharply (a typical scenario) we now have a window of data that shows rising prices followed immediately by falling prices. The ADX formula measures the rising prices in the window and compares them with the declining prices in the window. Because the two trends are about equal they cancel each other and the ADX does not detect any net directional movement. The ADX now begins to decline indicating that it is finding no net directional movement in the period measured by the window.

As the window moves forward, eventually the older rising price data falls outside the back of the window so that the window now contains only the more recent downward price movement. The ADX suddenly begins to rise rapidly because the data window at this point contains only one trend. The problem with this new signal is that the downward trend in prices has been underway for quite some time and only now has the ADX finally begun to rise. This is obviously not a good point to be entering a trade to the short side. We are probably nearer the end of the trend than the beginning.

Remember that the ADX works best after a basing period and is unreliable after a "V" bottom or top.
That"s all for now. I'll continue this discussion of the ADX in our next bulletin which should be out very soon.

Remember to visit the website often and participate in our FORUM discussions. Post anything you like that may be of interest to fellow club members. Also please feel free to forward this bulletin to a friend and invite them to visit our web site at http://traderclub.com


Chuck Le Beau will be speaking at a Seminar being conducted by Dr Van K.Tharp October 23 -25 in Cary NC. near Raleigh. The Seminar is titled " How to Develop a Winning Trading System that Fits You" (Advanced Workshop) As a special benefit to Traders Club Members, mention that you are a member of the Traders Club and receive a $150.00 discount on the cost of the Seminar. For enrollment information and details go to

Good Luck and Good Trading.