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Trend strength is an important part of trading directionally when it comes to most systems. A while ago, we looked at an additional criteria that a ProfitSource user employed at one of our software training sessions. This week I want to revisit this with examples from more recent market action.
The criteria is that the ADX – part of the DMI indicator – has been above 39 during Wave 3. The ADX is a trend strength indicator. A reading above 40 is considered to be a strong trend, while a reading below 20 is considered to be sideways or uncertain movement. Using a figure of 39 helps confirm that there has been recent momentum in the direction of the trade. This help us avoid Wave 4 trades on range trading markets.
Below is a recent example of this on Tele Norte (TNE).
Chart 1 – TNE Daily Wave 4 Buy
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It makes good sense to confirm the strength of the Wave 3 trend as this is meant to be the strongest move during a Wave 5 count. A low ADX reading (less than 39 for this discussion) during a potential Wave 3 indicates that there may not be a proper Wave 5 to follow and that the count may change to something else.
In Chart 2 we can see that TNE continued on to form a strong Wave 5 before returning back towards Wave 4. It is interesting to note that the ADX reading during Wave 5 was far weaker, even though the price action appears to be almost as strong. Keeping an eye on the ADX during Wave 5 can also indicate if a move back to Wave 4 is likely once Wave 5 is complete.
Chart 2 – TNE Wave 5
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Turning to a weekly chart we can see another recent example of a Wave 4 Buy, where the ADX has crossed above 39 during Wave 3.
Chart 3 –SDG Weekly Wave 4 Buy
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The constant challenge in technical trading is confirming that potential price set-ups are as they appear. Our goal is to weed out those that display enough characteristics to gain our attention but are unlikely to evolve into a profitable move. This ADX criterion is a simple but effective filter that can easily be applied to Wave 4 set-ups. It will help keep you out of sideways, choppy or weak markets. As always, be sure to test this for yourself before adding it to your trading plan.
Happy Trading
Jordan Craw
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