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ADXcellence

Power Trend Strategies


Dr. Charles B. Schaap
Using ADX, a trader can make the most amount of money in the least amount of tim
e.
ADX is the best indicator for trading power trends; it quantifies trend strength
, gives direction, and shows trend momentum. When ADX is applied in the context
of power trading principles, the result is an amazing opportunity to capitalize
on the strongest trends with the greatest potential for gain.

TABLE OF CONTENTS
Acknowledgements
Preface
Introduction
SECTION ONEPOWER TREND INDICATORS
Chapter 1
ADXcellence
Chapter 2
ADX/DMI Calculations
Chapter 3
DMI Xplained
Chapter 4
ADXplained
SECTION TWOPOWER TREND PRINCIPLES
Chapter 5
Power Trend Dynamics
Chapter 6
Power Trend Momentum
Chapter 7
Power Trend Volatility
ADXcellence
SECTION THREEPOWER TREND STRATEGIES
Chapter 8 Power Trend Principles 139
Chapter 9 Trading With Xcellence 159
Chapter 10 ADXodus
171
Chapter 11 ADXtra
179
Chapter 12 ADXpress
187
Chapter 13 ADXtender
197
SECTION FOURTHE POWER OF TIME
Chapter 14 Xpanding Time 211
Chapter 15 Time Lines
225
Chapter 16 ADXplosive 235
Chapter 17 ADXquisite 249
Chapter 18 ADXit
263
Appendix
269
About The Author
273

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##ACKNOWLEDGEMENTS
First and foremost, I must acknowledge the immense contribution of J. Welles Wil
der, Jr., who developed ADX and DMI. None of the material covered in this book c
oncerning ADX and DMI would have been possible without the pioneering work he co
mpleted over twenty-five years ago. I will consider it an honor if I can merely
further the understanding and interest in this amazing indicator.
While too numerous to list, I want acknowledge the contributions of all the stoc
k market educators who contributed to the knowledge of price, trend, momentum, a
nd volatility. I hope I have presented the material in a way that will help othe
r traders better understand key concepts so essential to the mastery of trading.
I need to recognize my parents, Charles B. Schaap, M.D., and Marie H.
Schaap, M.D. My father taught me the value of hard work, perseverance, and doing
one's best. My mother taught me to investigate, never assume, and be willing to
try new things.
I want to thank my wife, Candy, who encouraged me to write this book. She spent
countless hours listening to my ideas and theories. She helped me review charts
and gave constant feedback on the manuscript. And when I wrote at all hours of t

he night, she kept me fed with her gourmet Italian cooking!


Finally, I must thank my students and friends in the TraderDoc Club for their fe
edback and suggestions. They helped shape my thinking, improved the presentation
of my material, and gave me constant support.
PREFACE
I fell into my trading career by accidentliterally. After a fall that broke my ba
ck in two places, I was laid up in a body cast for six months. There wasn't much
to do except lay on the sofa and watch television or read. My wife had traded b
ond futures long before I met her, and she encouraged me to start trading to kee
p my mind active. She bought me some books on trading and I grabbed my yellow ma
rker and went at them like I was in medical school learning anatomy and physiolo
gy.
One night, we got the idea to travel to Italy to celebrate the removal of my bod
y cast. We went to the airport that night, bought tickets, and flew to Italy the
next morning. Every few days of the trip, we dashed into the nearest internet c
afe to manage trades we had put on before we left America.
Between cappuccinos and pasta, from Milan to Rome, we executed new trades and cl
osed out others. By the time we returned home to the USA, we had paid for our en
tire two week trip and made an additional twenty-six thousand dollars.
The Italy experience taught me two lessons. First, trading is stressful, and one
's pursuit of happiness should not be disrupted by constant trading. Second, our
best returns had come from strongly trending stocks we had left alone and not t
raded on the trip. From then on, I realized the job of a trending stock was to t
rend; and my job was to make a good entry, leave it alone, and take profits when
the stock quit doing its job.
I studied as much as I could about trendshow to spot them, when to trade them, an
d when to get out before they reversed. In searching for trend indicators, I dis
covered ADX, an indicator that told me when a stock was trending, in what direct
ion it was trending, and how strong the trend was. I started screening stocks fo
r strong trend strength, and then I looked for a pullback to enter the trend.
The more I studied ADX (and DMI), the more I liked it. However, I saw things wit
h ADX that I couldn't find discussed in any technical analysis books. Most of th
e material written on ADX seemed as though it didn't go far enough in explaining
how to use the indicator to its fullest. I began working on my own organization
al system for using ADX. I named things the way I saw and interpreted them. Even
tually, I had written a stack of pages on ADX and DMI.
As my trading life progressed, my wife and I started a club for traders to discu
ss ideas and teach technical analysis. In our chat room, I presented a few of my
ADX principles. The students seemed very interested, but when they asked where
they could read more about ADX, I wasn't able to give them a satisfactory refere
nce. After that, I created an online tutorial for the club; it was my first form
alized explanation of ADX.
One night in Las Vegas, my wife and I had dinner with our good friend, Ed Dobson
, a great trader and publisher (Trader's Press). Somewhere during the Chianti an
d linguine, I mentioned ADX and some of the research I had done with it. Ed said
he would love a book on ADX and urged me to write one. With my wife's encourage
ment, I decided to do it.
When forced to put my ideas into a format for readers, I discovered more about A
DX and DMI. Writing ADXcellence required a structure for teaching the concepts.
I wanted ADX to be used in the context of traditional technical analysis, and I
integrated concepts of trend, momentum, and volatility. The result was the core
material presented in this book.
In ADXcellence, I will present a thorough discussion of both ADX and DMI. I will
also present several strategies for trading power trend stocks. That way, you c
an let your stocks work for you, and you won't have to run in and out of interne
t cafes while trying to have a life. Remember, if your stocks work hard, you won
't have to.

INTRODUCTION
How you think is hoiv you trade. To change how you trade, you must firs
t
change how you think.
There are several hundred different technical indicators available to the trader
for analyzing price charts. I trade with oneADX (Average Directional Movement In
dex) and DMI (Directional Movement Indicator).
Most traders today are armed with too many indicators and too little understandi
ng of how to use them properly. Keeping things simple is a major challenge for t
raders in today's world of high-tech software, powerful computers, and a constan
t deluge of information. The excellence of ADX lies in its wealth of information
about trend, its simplicity, and straightforward signals.
For instance, ADX measures trend strength on a scale from 0-100. When ADX is les
s than 25, the trend is not strong enough to trade. When ADX is greater than 25,
the trend is strong and trades can be entered on trend retracements. This strai
ghtforward signal will keep the trader out of bad trends and guide them into goo
d ones.
Another example involves the positive and negative Directional Movement Indicato
rs (+DMI, -DMI), the indicators upon which ADX is calculated. When the +DMI is a
bove the -DMI, the trader should be long, not short. When the -DMI is above the
+DMI, the trader should be short, not long. The DMI signals are like a simple re
d light/green light system that can be easily followed.
One of the most simple, yet important concepts of ADX is its ability to identify
stocks ready to breakout into a power trend. The best and strongest trends begi
n out of periods where ADX has been under 25 for several weeks. Spotting these l
ow ADX periods gives the trader early notice of a potential new trend. Trading s
trategies presented in this book are based on power trends.
When ADX and DMI are combined as one indicator (ADX/DMI), the result is a powerf
ul indicator that can be used as a stand alone trading system. The three lines t
ell us about trend strength, direction, and momentum, all at the same time. It's
no wonder that ADX is so widely used by professional traders.
The book is constructed into four sections. Section One is an in depth look at b
oth ADX and DMI. I will present new concepts and terminology to help the trader
understand and interpret trading signals. For anyone familiar with ADX, you will
find I have greatly expanded on the traditional concepts.
Section Two will cover essential material for understanding how ADX/DMI is appli
ed in the context of basic technical analysis. ADX is a trend indicator, and tre
nd structure is a key to finding the best trading signals. I will also discuss A
DX/DMI momentum, and volatility.
In Section Three, I present my power trend principles and trading signals used w
ith ADX/DMI strategies. I detail four basic strategies for trading breakouts and
trend continuation patterns. Finally, in Section Four, I integrate the power tr
end strategies in the context of multiple timeframes. There are two more excelle
nt strategies given to take advantage of dual timeframes.
All of the strategies use price and ADX/DMI to find low risk, high probability e
ntries into trending stocks. Numerous chart examples will be given for the trade
r to study. ADX/DMI applies to all types of markets, and though the book will ma
ke reference to mainly stocks, the same principles apply to options, futures, co
mmodities, and currencies.
In each chapter, I highlight my ADX and DMI trading rules. The rules represent a
nchor points for understanding and using ADX/DMI, but they are guidelines only.
The trader must always trade on price first, and indicators second. The rules ar
e a handy shortcut to the key concepts and important information.
Personally, I believe ADX/DMI is the single best indicator for trading trends; i
t has greatly influenced my method of trading, and I sincerely hope it will do t
he same for you.
SECTION ONE

POWER TREND INDICATORS


##CHAPTER 1
This chapter presents an overview of ADX and DMIhow the indicators look and why
they are excellent power trend indicators. ADX is an essential tool for trading
with the trend strategies presented in this book.
Average Directional Movement Index (ADX) was developed by J. Welles Wilder and
presented in his book, New Concepts in Technical Trading Systems. ADX is derived
from two other indicators (also developed by Wilder) known as Positive Directio
nal Movement Indicator (+DMI) and Negative Directional Movement Indicator (-DMI)
.
The primary use of ADX is to measure trend strength. DMI determines trend direc
tion and confirms entry and exit signals. ADX is usually combined with +DMI and
-DMI to make one indicator consisting of three lines, as shown in the bottom cha
rt window of Figure 1.1.
When looking at a chart with ADX and DMI, first look to see if the +DMI is abov
e the -DMI, or vice versa. The top DMI gives the trend direction. Next, look at
the ADX line to see trend strength (value) and notice whether the line is rising
or falling (slope).
4 Chapter 1
Figure 1.1 QQQQDaily (Source: eSignal. www.eSignal.com)
Figure 1.1 is a daily chart of QQQQ showing the three indicator lines (ADX, +DMI
, -DMI). Throughout this book, ADX will be represented by the thick gray line. T
he +DMI will be the thinner, solid black line; and -DMI will be the dotted line.
To avoid confusion, when discussing the gray ADX line, I will refer to it as ADX
or the ADX line. When discussing ADX and DMI as one indicator (three lines), I
will refer to it as ADX/DMI.
On the right side of the ADX/DMI indicator are the numbers 0 and 50, along with
present values for the three indicators (gray shaded). ADX and DMI measurements
range from zero to 100. With eSignal's charting program, the upper limits of ADX
may not always show.
ADXcellence
5
GREEN LIGHT, RED LIGHT
If you look at Figure 1.1 again, you will see prices in July started trending up
and +DMI was above -DMI. In general, when +DMI is above -DMI, prices are trendi
ng up. When -DMI is above +DMI, prices are trending down. However, when price is
moving sideways, the DMI lines often give false directional signals.
The ADX line also started rising in July, showing trend strength was increasing.
When ADX is sloping upward, a trader can trade with the trend. But ADX is a lag
ging indicator, so the DMI lines are used for entry signals.
A DMI crossover occurs when the lower DMI crosses above the higher DMI. In Figur
e 1.1, the +DMI was below -DMI in June, and then crossed above it in July. The D
MI crossovers give us directional signals and often entry signals as well. If a
trader had entered this trade when +DMI crossed the -DMI, the trade would have w
orked out quite well.
On my trading computer, I make +DMI a green line and -DMI a red line. Under the
right circumstances, the DMI crossovers can be quite powerful and are the closes
t thing I've seen to a green light, red light system of trading. In general, tak
e the green light to go long (or cover shorts) when the +DMI crosses above the DMI and take the red light to go short (or exit longs) when -DMI crosses above +
DMI. In later chapters, I demonstrate how to filter out false crossover signals
and enter trades during low risk, high reward situations.
TREND STRENGTH
ADX quantifies trend strength (power) and helps identify the strongest trends to
trade and the weakest trends to avoid. I refer to strong ADX trends as "power t
rends" because they move higher, farther, and faster than weaker trends. A trade
r also reduces risk by trading power trends because they are less prone to deep

retracements. For instance, when entering long on a pullback in a strong uptrend


, price is more likely to continue in the direction of the trend; so the trade i
s less likely to be stopped out.
6 Chapter 1
ADX helps objectify our trend analysis. We have all heard comments like, "that s
tock looks like it's going higher/' or "that stock looks extended. These are opin
ions; ADX is objective. It is much better to say, "ADX is above 25 and rising, s
o price is likely to go higher," or "ADX is below 25 while price is rising, so t
he trend may be extended."
In strong trends, our goal is to make a low risk entry and ride the trend waves
by using a trailing stop and maybe adding to our position on pullbacks. The magi
c ADX number for a trend to be designated "strong" is 25. Once ADX rises above 2
5, the trader can use trend trading strategies. But when ADX falls below 25, pri
ce is usually in a consolidation period, and trend trading strategies will norma
lly fail.
ADX IS NONDIRECTIONAL
ADX measures the strength of a trend, but doesn't distinguish between uptrends a
nd downtrends. To determine direction, the DMI lines are used.
For this reason, the two DMI lines are usually overlaid on top of ADX. Together,
the three lines give us trend strength and direction.
When there is a strong uptrend, ADX rises. When there is a strong downtrend, ADX
also rises. It takes a little getting used to, but the more a trader uses ADX/D
MI, the more easily they will recognize the signals.
In the next chapter, I give guidelines to help show the proper trend direction u
sing ADX. For now, compare ADX in an uptrend (Figure 1.2) to ADX in a downtrend
(Figure 1.3).
7
Figure 1.2 HOLXDaily (Source: eSignal. www.eSignal.com)
HOLX shows a strong uptrend. Price is steadily rising and above the 20 EMA. The
+DMI is above the -DMI. ADX is above 25 and rising. When price and ADX rise toge
ther, it looks normal to the eye. During the uptrend seen here, the -DMI never c
rosses above the +DMI.
In general, when price is above the 20 EMA (seen above), the +DMI will be above
the -DMI. When price is below the 20 EMA, the -DMI will be above the +DMI.
8 Chapter 1
Figure 1.3 TZOO Daily (Source: eSignal. www.eSignal.com)
TZOO shows a strong downtrend. Prices are falling and are below the 20 EMA. The
-DMI is above the +DMI, confirming the direction is down. The ADX line is above
25 and rising, confirming the downtrend is strong.
For traders new to ADX/DMI, a rising ADX with falling prices takes some getting
used to. It is counterintuitive at first, but eventually it will look normal to
you. For the significance of ADX readings, look at the trend in prices and confi
rm the direction using DMI.
9
NEGATIVE DMI MOVES COUNTERDIRECTIONAL
While ADX is nondirectional, the -DMI moves "counterdirectional" to price. When
price declines, -DMI rises; and when price rises, -DMI falls. The movement of -D
MI is counterintuitive for most traders new to ADX/DMI. One way to make reading
-DMI easier is to only focus on the peaks when -DMI is above +DMI. When in doubt
, look at price for new pivot lows.
Always remember to look at price first, and indicators second. We don't need ind
icators to tell us the direction of price. When prices are making higher highs a
nd higher lows, we have an uptrend. When prices are making lower highs and lower
lows, we have a downtrend.
Moving averages are helpful for seeing trend. When price is below a declining mo
ving average, the trend is down for that timeframe. When price is above a rising

moving average, the trend is up for that timeframe. I cover moving averages in
more detail in Chapter 15.
We use DMI for price confirmation and to provide information about range expansi
on not easily seen with price alone. The DMI lines quantify the amount of range
expansion with readings between zero and 100. The DMI lines also help time entri
es and exits. I give rules for DMI trading signals in Chapter 3.
Look again at Figure 1.3 (TZOO). As price falls, -DMI rises and confirms the tre
nd is down. The -DMI peaks get higher and higher, confirming the downtrend is ge
tting stronger and stronger. You will also notice +DMI falls when price is falli
ng.
AN EXAMPLE OF ADXCELLENCE
I have found ADX/DMI to be the best indicator for measuring trend strength and d
irection. It empowers the trader with the information to best analyze trends and
provides timely signals for entries and exits. Figure 1.4 ($SPX) is a good exam
ple of the power in ADX/DMI.
ADXcellence
10 Chapter 1
Figure 1.4 (opposite page) is a weekly chart of the S&P 500 in 2000, before the
burst of the technology bubble, and after which the market entered a three-year
decline. The ADX was low (<25) in the summer of 2000, telling us the uptrend str
ength was weak despite rising prices in June and July. As I explain in later cha
pters, trends are ripe for reversal when they rise on low ADX readings.
With a low ADX, one certainly might have been suspicious of rising prices during
the summer of 2000. But when we look at the DMI lines, our suspicion turns to c
onfirmation. Notice how the -DMI crossed above the +DMI line in September. This
represented a bearish crossover and was a signal to be short, not long.
Price is always the ultimate "indicator" so let's see what price did when ADX/DM
I gave these signals. The -DMI crossover coincided perfectly with the S&P droppi
ng below its 50 week EMA, further evidence of a trend reversal. This shows how A
DX and DMI can be used to confirm price signals and strengthen our expectations
for a profitable trade.
ADX and DMI gave confirmatory signals the market was headed down. One might ask
how we know the change of trend direction was not a head fake or consolidation.
Just look at how the ADX line rose after the -DMI crossover in September. Compar
e its strength in late December (> 25, strong) to the low strength of ADX (about
10) before the crossover. Here, we see an example of relative ADX strength, a c
oncept I cover later. For now, just see how prices fell on "increased" ADX (tren
d strength), confirming the short signal.
The $SPX example shows us how powerful ADX can be in providing us with the infor
mation needed to trade successfully. Imagine having had the information to confi
rm the major market reversal in 2000!
ADXcellence
ADXcellence 11
Figure 1.4 SPXWeekly (Source: eSignal. www.eSignal.com)
This chart shows the top of the stock market in 2000. ADX and DMI gave excellent
signals to confirm the price reversal.
The breakout of prices below the 50 EMA coincided with a -DMI (bearish) "cross a
nd hold," a type of signal I will discuss in Chapter 3.
ADXcellence
12 Chapter 1
DECISION MAKING WITH ADX/DMI
Decision making can be the most stressful part of trading. Most traders are will
ing to work hard and do what is necessary to manage a trade, but they are someti
mes unsure about when to enter or exit a given trade. Indecision causes stress;
and when traders stress, they often make bad decisions.
It's no wonder traders constantly search for a magic indicator, a new trading sy
stem, or a better trading strategy. Unfortunately, the more a trader searches, t
he less they focus on the real basics of good trading. If a trader works to unde
rstand trend as a framework for understanding price action, they will be able to
apply any indicator or strategy with renewed confidence.

ADX/DMI will greatly add to any trading approach. ADX will not solve all of your
trading problems, but there is no better indicator with which to build a succes
sful trading system. ADX can answer many of your concerns about when and how to
trade. It provides a solid framework for understanding the larger context of a t
rade.
ADX will help with the following trading decisions:
When is a new trend just starting to break out?
When is a trend strong enough to buy on pullbacks?
When is a
trend getting weak and overbought?
When is a
trend reversing?
When is a
trend entering a consolidation?
In the chapters which follow, I describe how ADX works in each of these conditio
ns, and I will give you trading strategies to take advantage of the potential op
portunities.
ADXcellence
CHAPTER 2
ADX/DMI CALCULATIONS
The formulas used to calculate ADX and DMI are detailed in the Appendix. In this
chapter, I present ADX and DMI calculations more conceptually. The exact formul
as are not as important as understanding the relationships between price, range,
DMI, and ADX.
Understanding the theory behind a technical indicator gives greater meaning to i
ts use. Instead of just seeing lines on a chart, we begin to see the indicator m
ore conceptually. Ultimately, this leads to greater confidence and effectiveness
in using the indicator for trading decisions.
In the explanations that follow, be aware that DM stands for Directional Movemen
t and DMI stands for Directional Movement "Indicator." DM is based on daily rang
e expansion, and the DM values are used to calculate DMI. Then DMI values are us
ed to calculate ADX.
ADXcellence
14 Chapter 2
CALCULATING DM
To calculate DMI we must first calculate DM. DM is a measure of how much price m
oves outside of the previous day's range. When prices move higher, beyond the pr
evious day's high, there is upward range expansion and DM is positive (+DM). Whe
n prices move lower, beyond the previous day's low, there is downward range expa
nsion and DM is negative (-DM).
On any given day, there are four possibilities for new highs and/or lows:
Up dayprice makes higher highs
Down dayprice makes lower lows
Outside dayprice makes higher highs and lower lows
Inside dayprice makes lower highs and higher lows
On any given day, both +DM and -DM are calculated. However, some days will only
have +DM (up days), some will only have -DM (down days), some will have both +DM
and -DM (outside days), and some will have neither (inside days). DM does not c
oncern itself with where price opens or closes; it only looks to see if price ha
s made further upward range or downward range compared to the previous day. On i
nside days, there is no directional movement for the day.
To better understand how daily range affects DM, I will give two examples. Suppo
se we are looking at stock ABC which yesterday had a low of $18 and a high of $2
0 (Figure 2.1 left). Today was an up day, and ABC had a low of $19 and high of $
22. The +DM for the day was 2 (22-20=2). On the same day, ABC made a low of $19
which was above yesterday's low of $18. Since there was no movement below the pr
evious day's low, -DM is zero (18-19= -1, or 0). DM is never a negative number.
Suppose instead today's low had been $17, one point below yesterday's low of $18
(Figure 2.1 right). Then the -DM would be 1 (18-17=1). In this case,
ABC had both +DM and -DM in the same day (wide range bar).
ADXcellence
Calculations
15

Figure 2.1 Up day (left) and outside day (right)


22
z u
1 fS 17
CALCULATING DMI FROM DM
To calculate DMI, the +DM and -DM values are divided by "true range" for the day
(see Appendix, pg. 270). True range represents the total range for the day and
compensates for gaps and limit days (commodities) where the day's range is disto
rted. Dividing directional movement by True Range (and multiplying by 100) resul
ts in +DMI and -DMI. The DMI values represent what percent of the total daily ra
nge is due to +DM or -DM. Having a percentage allows +DMI and -DMI to be represe
nted on a 0-100 scale, making it an oscillator indicator with fixed boundaries.
To this point, both DM and DMI values represented one day compared to the previo
us day. For practical use, DMI is represented by a moving average using several
days of data. The values of both +DM and -DM are recorded for several days and a
veraged to better represent directional movement and reduce market noise. The de
fault moving average period is 14 days. Figure 2.2 is an example of the settings
I use for DMI (13) and ADX (8).
In Figure 2.2,1 show a chart with the settings (moving average periods) I use fo
r ADX and DMI. The chart is the basic type used throughout the book.
FORE
)^|NNer$RU
ADXcellence
16 Chapter 2
Figure 2.2 AAPLDaily (Source: eSignal. www.eSignal.com)
The settings I use for ADX and DMI are shown in the lower window of the chart ab
ove. The settings for both +DMI and -DMI is 13.
The +DMI is the thin black line; and the -DMI is the thin, dotted-black line. No
tice the two DMI lines generally move opposite of one another.
ADX is represented by the thick gray line, and the setting is eight (8). This se
tting makes ADX more sensitive to changes in trend strength and momentum.
ADXcellence
Calculations 17
CALCULATING ADX
ADX is derived from the relationship of the two DMI lines. The actual calculatio
n is made by taking the difference between the two DMI values, dividing by their
sum, and multiplying by 100. The result is a value between zero and 100, making
ADX an oscillator like DMI. The ADX line is also a moving average.
When the DMI lines are far apart, ADX will be high; when the DMI lines are close
, ADX will be low. When ADX is low, price is usually in a consolidation period;
when ADX is high, prices are usually trending. The relationship between the DMI
lines and ADX is important, and I discuss this in later chapters.
The three lines which comprise ADX/DMI allow the trader to see bull strength, be
ar strength, and overall trend strength at the same time. As you will see, this
feature is the cornerstone of accurate trend analysis.
ADXcellence
18 Chapter 2
Figure 2.3 APCC Daily (Source: eSignal. www.eSignal.com)
APCC is in a downtrend. Notice how close the two DMI lines are to each other in
September and how close they are to ADX. This is a consolidation pattern where p
rice moves mostly sideways.
Prices breakout to the downside in October and a downtrend begins. At the same t
ime, ADX begins rising, telling us trend strength is increasing. Because ADX is
nondirectional, it rises in a strong downtrend as well as a strong uptrend.
In early October, the -DMI rises and separates from the +DMI. The -DMI gives a d
irectional signal that confirms price action. During downtrends, the -DMI will r
emain above the +DMI; during uptrends, the +DMI will remain above the -DMI. When
the DMI lines separate, ADX rises.
ADXcellence
Calculations 19

Figure 2.4 WYNNDaily (Source: eSignal. www.eSignal.com)


This chart of WYNN has a more natural feel because price and ADX are both rising
in the same direction.
Since the DMI lines are moving averages, new DMI values get added to older infor
mation. As a result, recent price movement will have a different effect on DMI d
epending on what price movement preceded it.
When price has been going sideways for an extended period of time, the DMI lines
will be low, and any breakouts in price will cause a rapid change in the DMI. T
his is why the ADX/DMI indicator is so useful for confirming new trend breakouts
.
ADXcellence
20 Chapter 2
Figure 2.5 ALTRDaily (Source: eSignal. www.eSignal.com~)
ALTR shows a price breakout to the upside in late April. There is a sudden upwar
d surge in +DMI. Once a new trend breaks out, all of the DMI values used to calc
ulate the moving average will be high, not low. Even though price does not fall,
it may not advance at the same rate as it did on the breakout.
Consequently, the reaction by DMI to a price pullback may be more dramatic than
the change in price. As seen in this example of ALTR in late April and early May
, prices went sideways during the pullback while +DMI fell significantly.
The comparison of price to DMI helps us sort out the character of trend momentum
. Since price went sideways while the +DMI declined, the momentum is strong and
the trend is likely to continue.
ADXcellence
CHAPTER 3
DMI Xplained
The traditional role of DMI has been to give long and short signals when the two
lines cross. But DMI contains a wealth of other information about price and mom
entum. In this chapter, new DMI concepts are presented and new criteria for vali
d crossover signals are explained.
At any time, there are both bullish and bearish forces acting simultaneously to
influence price. It is helpful to think of the relationship between the two DMI
lines as a battle between the bulls (+DMI) and the bears (-DMI). These forces pl
ay out in all timeframes and at all times. The upward, bullish forces are measur
ed by +DMI and the downward, bearish forces are measured by -DMI.
The bulls and bears fight for trend dominance. There are periods where one is th
e stronger, dominant force, and price trends in one direction. There are times w
hen the bulls and bears are about equal in strength and price swings back and fo
rth without a dominant direction. At other times, the bulls and bears take a bre
ak and prices remain in narrow range.
ADXcellence
22 Chapter 3
One of the excellent features of the two DMI lines is they allow us to look at b
oth bullish and bearish forces at the same time. This relationship between the t
wo DMI lines is the key to understanding how and when to use ADX most effectivel
y
DIRECTION AND DOMINANCE
The two DMI lines indicate trend direction. The direction is given by the DMI on
top. Like any momentum indicator, the DMI lines give the best signals when they
are compared to price movement.
DMI Direction Rule When the +DMI is above -DMI,
the trend direction is up. When the -DMI is above +DMI, the trend direction is d
own.
One DMI line is always on top, except at the point of crossover. The DMI on top
is called the dominant DMI. Most of the focus is on the dominant DMI when lookin
g for trading signals since it is the stronger of the two lines. During periods
of low volatility (consolidation), the dominance may not be clear because the li
nes often crossover frequently.
At the point where the DMI lines cross, the bull and bear forces are exactly equ
al in value, but not necessarily in force. The force is determined by both value

and slope. When the slope is weak, no real dominance existsno matter what DMI is
on top. Relative equilibrium occurs when the two DMI lines are moving sideways
and are close to one another. It is from this type of equilibrium that some of t
he best trend breakouts occur.
DMI Equilibrium Rule When the +DMI and -DMI are below
25 and moving sideways, the trend has no dominant direction.
ADXcellence
DMI Xplained 23
Figure 3.1 TXN Daily (Source: eSignal. www.eSignal.com)
TXN is an example of the changeover in DMI dominance. The shaded areas on the ch
art highlight -DMI before and after the crossover point.
In October, the -DMI was dominant during the downtrend in prices. The bears were
in control.
In early November, the +DMI crossed above -DMI and the bulls took over dominance
. The +DMI confirmed the price uptrend that ensued.
ADXcellence
24 Chapter 3
Figure 3.2 JBLU Daily (Source: eSignal. www.eSignal.com)
This chart shows a period of "no dominance/' followed by a trend breakout where
dominance is established. The ADX line is not shown in order to see the DMI line
s more clearly
JBLU is moving sideways from October to mid December, 2005. The DMI lines are mo
ving sideways with frequent crossovers that fail to make new highs. The DMI line
s remain below 25 for the majority of the time.
There is no trend direction until late December when price breaks out and the +D
MI gains dominance. During sideways price movement, the DMI lines are in equilib
rium.
ADXcellence
DMI Xplained 25
EXPANSIONS AND CONTRACTIONS
Expansions occur when the DMI lines move away from one another.
Contractions occur when the DMI lines move toward one another.
ADXcellence
26 Chapter 3
Expansions and contractions are visual clues to the degree of range expansion/co
ntraction taking place with price movement. These two patterns will be important
when we look at the strategies that integrate price momentum.
The more the DMI lines expand, the stronger the directional movement (up or down
). The more the lines contract, the weaker is the directional movement (up or do
wn). Expansions and contractions are a normal part of the up and down movement w
ithin price trends. Before a DMI crossover, the lines must contract; but contrac
tions may or may not lead to a crossover depending on the trend strength. After
an expansion, the longer the lines go without crossing, the stronger the trend o
f the dominant DMI.
When the +DMI is dominant during an expansion, it is called a positive expansion
and occurs in an uptrend. When the -DMI is dominant during an expansion, it is
called a negative expansion and occurs in a downtrend. Expansions can be compare
d to one another: positive to positive, negative to negative, and positive to ne
gative.
Expansions can be a single DMI peak or a series of peaks. The end of the expansi
on is made by the highest DMI peak recorded before contracting. The end of the c
ontraction is made by the lowest DMI peak recorded before expanding.
Expansions and contractions are easy to spot on a price chart, and when you can'
t see them, the trend is going to be choppy and not worth trading. The significa
nt expansions occur when the top DMI is rises above 25. The significant contract
ions occur when the top DMI drops below 25.
As a trend strengthens, the expansions get wider. As a trend weakens, the expans
ions get narrower. Expansions and contractions are easy DMI patterns to recogniz
e and give us insight into price movement.
When trading power trends, breakout entries are best at the beginning of the exp

ansions. Pullback entries are best at the end of contractions. These patterns pr
ovide visual clues to assist in trade management.
ADXcellence
DMI Xplained 27
Figure 3.5 GOOGDaily (Source: eSignal. www.eSignal.com)
This daily chart of GOOG shows two expansions and two contractions. The expansio
ns are indicated by the arrows; the contractions are shown by the trendlines.
During expansions, the DMI lines separate. During contractions, the lines come c
loser together. The second expansion (right) is wider than the first (left), tel
ling us the trend momentum is increasing.
In contrast, the second contraction (right) is less narrow than the first (left)
, telling us there is less downward momentum at this point in the trend.
ADXcellence
28 Chapter 3
DMI AND VOLATILITY
DMI behaves differently in high volatility versus low volatility. When volatilit
y is high, the DMI lines are farther apart, and they must travel farther toward
one another before a crossover. In low volatility conditions, the DMI lines are
closer together, and they do not need to travel very far to make a crossover.
DMI Volatility Crossover Rule In high volatility conditi
ons, DMI crossovers are lagging signals. In low volatility conditions, DMI cross
overs are coincident signals.
This is an extremely powerful concept, and one which applies to other areas of t
rading as well. It simply means when volatility is low, the DMI lines become mor
e sensitive to range expansion and give early crossover signals. When volatility
is high, the DMI lines become less sensitive to range contraction and give late
crossover signals.
DMI PIVOTS
Note: If you are not familiar with how to identify "pivots," quickly review Chap
ter 5, page 82 before reading this section.
The two DMI lines pivot like prices. DMI pivots are points where DMI makes a cha
nge of direction, forming a peak or trough. They represent points where range ex
pansion has turned and headed in the opposite direction. Not all pivots are sign
ificant because the DMI lines are subject to noise like any other indicator. Any
pivot before or after a DMI crossover is of major importance when looking for t
rade signals.
The important concept regarding DMI pivots is they must correlate with price. It
is price that determines which indicator pivots are important. Any DMI pivot us
ed for a trading signal must correlate with a price pivot. When price makes a pi
vot high, it must correlate with a +DMI pivot high. When price makes a pivot low
, it must correlate with a -DMI pivot high.
ADXcellence
DMI Xplained 29
Figure 3.6 BOOMDaily (Source: eSignal. www.eSignal.com)
This chart is an example of how DMI crossovers lag in high volatility conditions
.
In this daily chart of BOOM, price reverses direction quickly after a big expans
ion in November. However, the -DMI crossover occurs over a month later.
During high volatility, a trader should not wait for a DMI crossover to exit a t
rade. Instead, use DMI divergence as a warning and exit on price. DMI divergence
is covered later in this chapter.
ADXcellence
30 Chapter 3
Figure 3.7 EXPDDaily (Source: eSignal. www.eSignal.com)
EXPD has a long period of low volatility consolidation in September. The DMI lin
es are below 25 and cross frequently. Frequent crossovers are a common feature o
f low ADX periods when price has no dominant direction.
In mid October, prices breakout into an uptrend and the +DMI makes a crossover h
igh (discussed later, pg. 36) at the same time. In low volatility, the crossover
signals are generally coincident with price and can be used to confirm price fo

r an entry signal.
ADXcellence
DMI Xplained 31
Figure 3.8 AAPL Daily (Source: eSignal. www.eSignal.com)
Note: +DMI pivot highs are show by (parentheses), and -DMI pivot highs are show
by [brackets],
1. The price pivot high correlates to the +DMI pivot high.
2. The higher price pivot high correlates to the lower +DMI pivot high. This
is evidence of negative (bearish) divergence. Notice how price fell after the d
ivergence.
3. This is a price pivot high following a +DMI crossover, but the +DMI peak
was not higher than the preceding -DMI (6). The DMI peaks before and after cross
overs are more significant for trade signals.
4. Price made a pivot low, and -DMI made a pivot high.
5. The -DMI at [5] made a peak, but there is no clear pivot low in price, so
the -DMI peak is disregarded.
6. This is the lowest price pivot of those under study, and it corresponds t
o the highest -DMI peak.
ADXcellence
32 Chapter 3
DMI DIVERGENCE
Most traders are familiar with the concept of momentum divergence. The primary u
se of momentum indicators is to confirm price action. When price and indicator a
gree, there is confirmation, or convergence. When price and indicator do not agr
ee, there is nonconfirmation, or divergence.
These signals are extremely important in determining possible areas of price rev
ersal or retracement. When divergence is present, it is often time to take profi
ts and wait until price and indicator give us the next signal.
To study momentum, trendlines are commonly drawn on nearby price pivots as well
as DMI pivots to compare them. When +DMI and price are negatively divergent (bea
rish), the trendlines will slant in the opposite direction. When -DMI and price
are positively divergent (bullish), the trendlines will slant in the "same" dire
ction
Figure 3.9
ADXcellence
Figure 3.10
DMI Xplained 33
DMI TRIGGER PIVOTS
DMI pivots are points where DMI makes a change of direction, forming a peak or t
rough. They represent points where range expansion has turned and headed in the
opposite direction. But DMI pivots, like price pivots, must have follow through
to be valid.
A trigger pivot is similar to a price pivot reversal. When price makes a pivot l
ow and then reverses to make a new pivot high, we look to +DMI for confirmation.
The confirmation is when +DMI reverses off of its pivot low and makes a new +DM
I high. Both +DMI and -DMI trigger pivots occur.
The important thing to remember is that for valid entry signals, DMI pivots must
correlate with price pivots, and price pivots must correlate with DMI pivots. I
f price makes a pivot low reversal (up), but +DMI does not make a trigger pivot
(new high), then the long entry is not valid. If price makes a pivot high revers
al (down), but -DMI does not make a trigger pivot (new high), then the short ent
ry is not valid.
Trigger pivots are the main filter used for making good entries and avoiding bad
ones. I will cover pivots in more detail in Chapter 6 on power trend momentum.
ADXcellence
34 Chapter 3
Figure 3.11 AMGN Daily (Source: eSignal. www.eSignal.com)
1. The -DMI makes a new high following a pivot low. At the same time, price
makes a pivot high reversal (down). Price and -DMI agree, and this is a valid sh
ort signal.

2. The +DMI makes a new high following a pivot low. At the same time, price
makes a pivot low reversal (up). This is a valid long signal.
3. The +DMI makes another new high following a pivot low. At the same time,
price makes another pivot low reversal (up). This is also a valid long signal.
Trigger pivots confirm price triggers and give us confidence to enter in the dir
ection of price momentum. I will cover pivot reversals in detail in Chapter 5 on
power trend dynamics.
ADXcellence
DMI Xplained 35
DMI CROSSOVERS
DMI crossovers occur when the bottom DMI crosses above the top DMI (they switch
positions). While one DMI is technically crossing down, it is the DMI crossing u
p which is the basis of all our DMI entry signals. There are two types of valid
DMI crossovers which are used repeatedly in the trading strategies presented in
later chapters.
Each time a DMI crosses up, it is challenging the other DMI, trying to overtake
it and stay on top. It is normal for them to go back and forth until one DMI has
the strength to stay on top for an extended period of time. When this happens,
price will trend.
Figure 3.12 ISILWeekly (Source: eSignal. www.eSignal.com)
This chart shows a cup pattern. At the bottom of the cup there is a +DMI crossov
er. The bulls took over dominance from the bears. To tell if a DMI crossover is
valid, we must understand the two patterns presented next.
ADXcellence
36 Chapter 3
Crossover High
Traditionally, DMI crossovers are signals to go long when +DMI crosses up and go
short when -DMI crosses up. While this works often, it also fails frequently un
der many conditions. The crossover high acts as a filter to improve the validity
of crossover signals. The crossover high is common and used in many power trend
strategies.
The crossover high (See Figure 3.13) combines the basic crossover with a higher
opposite DMI peak above 25. A higher opposite high occurs when the +DMI makes a
higher high than the preceding -DMI; or when the -DMI makes a higher high than t
he preceding +DMI.
DMI Crossover High Rule
A LONG crossover high signal occurs when a +DMI crossover makes a higher
opposite high above 25. A SHORT crossover high signal occurs when a -DMI crossov
er makes a higher opposite high above 25.
We know the greater the range expansion in price, the higher the DMI line will g
o on any given price swing. The crossover high meets two important criteria for
a valid signal: 1) the DMI rising above 25 means there is sufficient strength to
trend, and 2) the DMI making a higher opposite high means it is strong enough t
o takeover dominance. Entries are made on a retracement after the crossover high
.
ADXcellence
DMI Xplained 37
Figure 3.14 NVDADaily (Source: eSignal. www.eSignal.com)
This daily chart of NVDA shows a classic +DMI crossover high and subsequent uptr
end. The first high made by the +DMI was not higher than the preceding -DMI high
, so it is not a valid crossover high. The subsequent +DMI peak is higher than t
he preceding -DMI, and the +DMI value is above 25; so this was a valid crossover
high.
At this point, we have momentum moving in up direction with sufficient strength
to consider applying a trading strategy. Price breakouts need to have significan
t strength to continue, otherwise price will turn in the other direction, and tr
ades get stopped out.
The bottom DMI has to be stronger than the top DMI if it is going to take over t
he dominant position. Sometimes, the DMI can cross and get to 25, but the opposi
te DMI peak might be at 35. The higher DMI remains dominant until proven otherwi

se. It is the new DMI high that establishes new DMI dominance.
ADXcellence
38 Chapter 3
Figure 3.15 ACI Daily (Source: eSignal. www.eSignal.com)
Note: ADX line not shown.
Crossover high failures can occur in two ways described below:
The crossover DMI peaks below 25. This is common in low volatility.
The crossover DMI peaks above 25 but below (or equal to) the preceding pea
k (opposite DMI peak). This is common in high volatility.
This daily chart of ACI shows two crossover high failures. In both examples, the
-DMI crossed above the +DMI and peaked above 25. But the -DMI peak was equal to
or lower than the preceding +DMI peak. In the price chart above, you can see wh
ere the failures did not lead to downtrends.
Avoiding these crossover high failures will prevent countless bad entries.
ADXcellence
DMI Xplained 39
Cross and Hold
A cross and hold (See Figure 3.16) is the second type of crossover used for powe
r trend strategies. A cross and hold is really a delayed crossover high. The DMI
crosses up and fails to make a new high on the crossover swing; but it manages
to "hold" above the opposite DMI. The DMI has the power to crossover and remain
above the opposite DMI, but not enough power to make new highs.
The cross and hold is considered to be temporary dominance. Our trade bias is wi
th the dominant DMI. A cross and hold DMI must make new highs to establish new t
rend direction.
The cross and hold is a frequent setup for breakout trades. The DMI gathers stre
ngth before the breakout, and we usually see it pull back a little before going
higher. As long as the pullback does not cross back down, we can wait for a vali
d new high signal (trigger pivot).
For instance, if +DMI makes a crossover and holds above the -DMI, we have a cros
s and hold. This will become a valid signal if the +DMI can then make a new high
above 25. For cross and holds, we usually enter the trade on the breakout; a bu
y stop can be set to pull you into the trade.
ADXcellence
40 Chapter 3
Figure 3.17 ISILWeekly (Source: eSignal. www.eSignal.com)
{ISIL - INTERSIL CORP.W} Dynamic,0:00-24:00
24.00
?? rvn 51.60
20.00
18.00
16.00
14.00
30
20
13.11
10
*itt tw I"
liiul([tt*li,i ri ,t*ll V'l.
W
.............r*
Dir^ttojrial Movement{14,14)Qj-Qgg ...........................!
Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
2005
Note: ADX line not shown.
We had a cross and hold in our weekly chart of ISIL in February, 2005. On the +D
MI crossover, the +DMI was unable to make a higher opposite high. Therefore, the
re was no confirmation of a long signal. Price moved sideways after the +DMI cro
ss and hold because price was not strong enough to begin a new trend.
The hold correlates to a price retest and is a sign that strength is increasing
for the bulls. After further sideways movement in price, the +DMI finally makes

a higher high and price breaks out into an uptrend.


You will notice in late April the -DMI made a crossover but failed and quickly c
rossed back down below +DMI. This is why we have the concept of DMI dominance an
d the DMI failure cross (both covered next).
ADXcellence
DMI Xplained 41
DMI DOMINANCE
The concept of DMI dominance is important for developing a bias on market direct
ion. Dominance does not predict direction, but it does give an edge. The dominan
t DMI tells us whether the bulls or bears are in control at any given time. Bein
g on top does not mean you can stay there, but the odds are in your favor.
DMI Dominance Rule A DMI becomes dominant after a crosso
ver high or cross and hold and remains dominant until the opposite DMI does the
same.
The concept of DMI dominance is important because it tells us where the range ex
pansion (trend) is likely heading. If the +DMI is dominant, then we will look fo
r new highs in price and new highs in +DMI. If the -DMI is dominant, we look for
new lows in price and new highs in -DMI. In planning our trades, our bias is to
ward the dominant DMI.
DMI FAILURE CROSS
A DMI failure cross is a DMI crossover which quickly crosses back down without m
aking a pivot low while on top. There is no change in dominance. If the DMI can
make a pivot low while on top, it becomes a cross and hold. In other words, a fa
ilure cross is any DMI crossover that fails to make either a crossover high or c
ross and hold.
Failure crosses are important because they show the failed DMI is very weak and
cannot challenge for dominance. If a -DMI makes a failure cross, the bulls are s
till in control and the bears have been rejected. If a +DMI makes a failure cros
s, the bears are still in control and the bulls have been rejected. Failure cros
ses in high volatility can be the basis for countertrend trades at support and r
esistance. Failure crosses in low volatility are common and should be disregarde
d.
ADXcellence
42 Chapter 3
Figure 3.18 NTAPDaily (Source: eSignal. www.eSignal.com)
(NTAP
NETWORK APPLIANCE INC,D) Dynamic,0:00-24:00
Copyright O 2004
Directional
This daily chart of NTAP provides a good example of the failure cross:
1. Price makes a new high in September, but the +DMI does not make a new hig
h. The bulls are rejected. The shaded area represents the period of -DMI (bear)
dominance.
2. Price broke out again in October, and the +DMI made a crossover high. Now
the bulls take control.
Understanding DMI dominance is a key to good money management.
Traders want to make the most amount of money in the shortest period of time. En
tering long without a dominant +DMI puts money at risk to downside swings, and s
itting through sideways price movement exposes the trader to the lost value of t
ime.
ADXcellence
DMI Xplained 43
DMI CONTINUATION HIGH
A DMI continuation high is a new DMI high following a contraction in the DMI lin
es. Continuation highs occur following price retracements if DMI dominance remai
ns intact.
DMI continuation highs are more common in the stronger trends. The hallmark of t
he DMI continuation high is a new DMI high after price tests support or resistan
ce. The new DMI high must follow a contraction where dominance is maintained and
there is no DMI crossover.

DMI Continuation High Rule During a retracement when DMI


dominance is maintained, a new high in the dominant DMI confirms continuation of
the trend.
We apply this rule with the ADXtender strategy which I present in Chapter 13. The
fact that the dominant DMI was not crossed during the retracement means the tre
nd strength is very strong. The DMI lines may come close enough to touch, or "ki
ss," during the retracement; but they do not cross.
ADXcellence
44 Chapter 3
Figure 3.20 CCRTDaily (Source: eSignal. www.eSignal.com)
DMI Continuation High in an Uptrend
CCRT shows an initial breakout in May, followed by a consolidation of prices dur
ing June. During the consolidation, the -DMI never crosses the dominant +DMI.
At the end of June, price breaks out above resistance, accompanied by a DMI cont
inuation high. DMI continuation highs are only valid if price also makes new hig
hs.
Notice in this chart that ADX also turns up and goes to higher highs with the tr
end continuation.
ADXcellence
DMI Xplained 45
Figure 3.21 DELLDaily (Source: eSignal. wvyw.eSignal.com)
DMI Continuation High in a Downtrend
DELL gapped down in August and entered a downtrend. During September, prices mov
ed sideways for a week, then broke below support. Concurrently, the -DMI made a
new high. At no time since the downtrend began did +DMI cross the -DMI. The new
-DMI high is a continuation high.
The DMI continuation highs look differently for downtrends because -DMI moves co
unterdirectional to price. After prices retrace UP to resistance, look for new p
rice lows and new -DMI highs.
ADXcellence
46 Chapter 3
PRICE AND DMI CORRELATION
DMI peaks are always correlated with price pivots in order to understand the sig
nificance. When price makes a pivot, then the DMI pivot can be used for comparis
on. When price does not make a true pivot, but DMI pivots, ignore the DMI pivot.
When DMI forms a pivot, and price does not, it is a false DMI pivot. The DMI lin
es make "false pivots" based on price noise. Do not take signals off of false DM
I pivots. Valid entry signals always require both price and DMI to make pivot re
versals.
In general, only be concerned with DMI pivots that are dominant and correlate to
a price pivot. For dominant +DMI peaks, we look at pivot highs. For dominant -D
MI peaks, we look at pivot lows.
DMI DIVERGENCE AND CONVERGENCE
One of the things momentum indicators do is give us momentum divergence with pri
ce (discussed earlier, pg. 32). DMI divergence is important for seeing areas of
potential retracement risk for a stock position. Short-term trades can be taken
off divergence signals, but their primary use is to serve as a warning of moment
um weakness in a price swing. When DMI is divergent with price, price will usual
ly enter a countertrend retracement or reversal. Knowing this, the trader can be
tter manage risk.
In contrast, DMI convergence means DMI and price are in sync. As long as DMI is
making higher highs and price is making higher highs/lows, stay with the trend.
DMI convergence is helpful for staying in a position in the early part of the br
eakout when you might be concerned about false breakout moves. It is also a sign
that positions can be added to on a pullback.
ADXcellence
DMI Xplained 47
Figure 3.22 APPL Daily (Source: eSignal. www.eSignal.com')
Managing Risk with DMI in an Uptrend
Note: The ADX line is not shown.

C = Convergence D= Divergence
When price and DMI are divergent, manage risk more closely. That may mean taking
partial profits or tightening the stop. Divergence (D) in an uptrend is usually
followed by a retest of the previous lows. In both cases of divergence above, p
rices retraced or consolidated.
When price and DMI are convergent, stay in the trade, but still manage risk with
a trailing stop. Convergence (C) in an uptrend is usually followed by a retest
of the previous highs. In both cases above, convergence led to continuation of t
he trend.
ADXcellence
48 Chapter 3
Figure 3.23 SYMC Weekly (Source: eSignal. www.eSignal.com)
This chart shows two bearish divergences, one that led to a retracement and one
that led to a trend reversal.
On the left (March-April, 2004), SYMC demonstrated +DMI (bearish) divergence tha
t resulted in a retracement only.
On the right (October-November, 2005), there is +DMI (bearish) divergence which
led to a trend reversal.
DMI divergences are a warning, not evidence of a trend reversal. Divergence sign
als are only valid for a test of the previous swing high/low; based on the test,
price may continue the trend or enter a reversal. More often than not, the tren
d will continue after a test of support/resistance.
ADXcellence
CHAPTER 4
ADXplained
ADX helps us identify the strongest trends to trade and the weakest trends to av
oid. In this chapter, I explain how ADX is used to accurately read trend dynamic
s, and I present rules needed for trading power trends with ADX.
ADX gives an objective value for trend strength, but the slope and patterns of t
he ADX line are also important. Much can be learned about trend momentum by obse
rving how the ADX line behaves during a strong trend.
ADX peaks can be compared to other ADX peaks, both during the trend legs and the
retracements. The relationship between the DMI lines and ADX is also important
for distinguishing between breakouts, retracements, and continuation patterns.
TREND STRENGTH AND MOMENTUM
ADX is an oscillator and swings up and down between fixed boundaries of zero and
100. Oscillators measure momentum, or the velocity of price. The ADX line gives
us a visual representation of trend momentum, and the ADX values tell us the un
derlying trend strength. The combination of these two features account for the i
ndicator's "Xcellence."
ADXcellence
50 Chapter 4
ADX does not behave like traditional oscillators. There are no fixed "overbought
" or "oversold" levels such as those for RSI or stochastics. ADX values under 25
are common, while values over 75 are not common.
The most important thing to remember is price swings with an ADX greater than 25
are strong enough for trend trading strategies. Price swings with an ADX below
25 are best avoided until a price breakout or continuation.
Values under 25 represent retracements or sideways consolidation. ADX can remain
below 25 for extended periods of time when a stock is relatively inactive. ADX
is normally below 25 during a stock's accumulation phase, although it may rise a
bove 25 for short periods of time.
In general, values over 75 are seen in trend climaxes and warn of a trend retrac
ement or reversal. ADX does not remain above 75 for very long without dropping l
ower. Steady trends have ADX values between 25 and 50.
ADX Trend Strength Rule
When ADX is above 25, trend strength is strong enough for trend trading
strategies; when ADX is below 25, avoid trend trading strategies.
An ADX reading of 25 is the over/under level for trend strength. When ADX rises
above 25, the trend is considered both valid and strong. It is valid because it

is real strength, and it is strong because the trend has enough force to continu
e.
ADXcellence
ADXplained 51
The following values are important references and are used in power trend tradin
g strategies. They are guidelines and must be correlated with price action.
ADX Value Trend Strength
0-15
Very Weak
15-25
Weak
25-50
Strong
50-75
Very Strong
75-100
Extremely Strong
The higher the ADX reading, the stronger is the trend. The lower the ADX reading
, the weaker is the trend. A trader should always keep trend strength in context
with price action.
Low trend strength may not be good if the trader is long and looking for a trend
to continue. But low trend strength is preferred when looking to buy a breakout
from consolidation. Likewise, high trend strength may be good when long in a tr
end; but if ADX gets too high, it may be a warning to take profits before the tr
end retraces or reverses.
The 25 level for ADX must be placed in context of the trend and price swings. If
price has been in a trading range for two weeks and suddenly makes a new shortterm high, then an ADX reading of 25 would likely indicate the beginning of a ne
w leg in the trend. But if price makes a long swing up to a previous resistance
level and ADX just reaches a level of 25, it would likely indicate the end of th
e price swing.
Think of ADX as the "gas pedal" for trends. When ADX is rising, the gas pedal is
down. When ADX is falling, the gas pedal is let off. When ADX is very high and
rising, the pedal is to the metal. If the ADX is low and moving sideways, the tr
end is idling and going nowhere.
ADXcellence
52 Chapter 4
Figure 4.1 ESRXDaily (Source: eSignal. www.eSignal.com)
This is an example of how a trend can gather strength once the ADX is greater th
an 25.
ESRX gapped up in late July with an ADX that barely reached the 25 level. Price
went sideways until mid-August when ADX rose above 25 and price started a steady
climb. ADX remained above 25 during the entire move from $50 to $79.
The 25 level is the over/under level for trend strength. When ADX rises above 25
on a price breakout, a trade can be entered on the pullback. Subsequent pullbac
ks can be entered as long as ADX continues to make surges above 25.
This concept is used in the ADXtender strategy (Chapter 13).
ADXcellence
ADXplained 53
Figure 4.2 BOOMWeekly (Source: eSignal. www.eSignal.com)
Figure 4.2 is a weekly chart of BOOM. Look at the point where +DMI crossed above
the -DMI and where ADX crossed above 25 (dashed horizontal line). Price takes o
ff and starts a very strong uptrend. Once ADX gets above 25, the first pullback
can be entered.
Also, notice that ADX remained above 25 for the entire length of the trend. Thes
e are ideal conditions for trading a trend.
The ADX in strong trends will remain above 25. During price retracements, ADX ca
n fall near 25 and the trend is likely remain intact. When ADX falls below 25, t
he trend dynamics may change.
ADXcellence
54 Chapter 4
Figure 4.3 PD Daily (Source: eSignal. www.eSignal.com)
Here we see ADX rising above 25 in the two shaded areas. However, price had alre
ady advanced the length of the previous downswing when ADX went above 25.
Therefore, these are not good signals for making a long entry in what might appe

ar as a strong trend when gauged by ADX alone. Always compare ADX to price actio
n.
This ADX pattern is better suited for countertrend trades off support or resista
nce; but that type of trade is not a power trend trade.
ADXcellence
ADXplained 55
LOW ADX AND PRICE PATTERNS
When ADX is low for any length of time, price patterns develop. The ADX can be m
oving sideways under 25 or be under 25 and declining. The patterns are frequentl
y triangles (ascending, descending, symmetrical, and asymmetrical). This is one
of the most overlooked features of ADX. Finding price patterns with ADX below 25
suggests a breakout is likely to occur. The best power trends follow a period o
f low ADX.
During low ADX periods, any indicator will give poor signals for momentum or tre
nd. When ADX is low for a period of more 20 bars or more, it is best to draw tre
ndlines on price and wait for a new price breakout. No trend trading signal is t
aken unless price breaks out of the price pattern. Likewise, if a trader has a p
osition in a stock and the ADX falls under 25, it is a warning the stock may be
entering a consolidation period.
ADX Trendline Rule
When ADX is below 25 for an extended period (>20 bars), draw trendlines o
n price and wait for a breakout.
ADX SLOPE
The slope of ADX is as important as the value. When the slope of ADX is rising,
trend strength is increasing. When the slope of ADX is falling, trend strength i
s decreasing. A falling ADX is common during retracements. It is important to no
te that a falling ADX does not mean the trend is going to reverse. Most trend re
versals are preceded by a period of price consolidation where ADX declines under
25.
ADX Retracement Rule The ADX slope will rise during
strong trend legs and decline during retracements.
ADXcellence
56 Chapter 4
Figure 4.4 EOGDaily (Source: eSignal. www.eSignal.com)
This consolidation triangle formed as a continuation pattern in an uptrend. The
ADX was high during the uptrend leg in July, and then it fell under 25 during th
e consolidation of about 20 days. A falling ADX slope means the trend is weakeni
ng, something that commonly occurs during retracements. Price eventually broke o
ut to the upside for a nice gain.
In September, we see ADX above 25 and rising steadily. Price is rising more stee
ply. A high ADX means the trend is strong; and a high ADX with a rising slope is
means the trend is strong and getting stronger.
When ADX is high and the slope is falling, the trend is weakening, despite the h
igh ADX reading. This condition precedes retracements and can precede a trend re
versal. In contrast, a low ADX reading with a rising slope may be the beginning
of new trend strength. In this situation, while ADX is low, the rising slope is
telling us the strength is increasing.
ADXcellence
ADXplained 57
Figure 4.5 NAVDaily (Source: eSignal. www.eSignal.com)
Here is a symmetrical triangle that formed after a long period of low ADX. When
prices broke out to the downside in October, ADX rose above 25. In mid to late O
ctober, the ADX declined when prices retraced back up to the moving average.
ADX is nondirectional. During an uptrend, ADX will fall during retracements DOWN
in price. During a downtrend, ADX will fall during a retracement UP in price.
ADXcellence
58 Chapter 4
Figure 4.6 BRCMDaily (Source: eSignal. www.eSignal.com)
In this chart, the shaded areas represent the periods of rising ADX. During an u
ptrend, these are the times to be long and when most of the gains will be realiz

ed. The periods where ADX is falling represent retracements, times when the trad
er must decide to remain in the trade or take profits and wait for another long
entry.
A trader can also hold their position, take partial profits, or sell call option
s. Selling options is a good strategy if the trader intends to hold the stock be
cause retracement (consolidation) periods can eat up time, and one might as well
get paid (option premium) to hold on to a stock when it moves sideways.
ADXcellence
ADXplained 59
Here is an example of rising ADX slopes in a downtrend. It may seem counterintui
tive because ADX is nondirectional. In downtrends, ADX rises when price makes a
new leg down.
In a downtrend, ADX will slope down during retracement periods as seen in Septem
ber and November. Little downtrend progress is made in the direction of the tren
d during periods where the slope of ADX is falling.
ADXcellence
60 Chapter 4
INTRATREND ADX STRENGTH
If a strong uptrend exists, prices make a series of higher highs and higher lows
. When our eyes see higher and higher prices, we may think the trend is getting
stronger and stronger and the ADX should go higher and higher. But this is a mis
conception about ADX.
ADX does not need to go higher and higher for prices to continue rising in an up
trend or falling in a downtrend. Once price has sufficient momentum to develop i
nto a strong trend, it doesn't take as much momentum to keep the trend going. Th
is is just like driving a car. We have to step on the gas to accelerate up to hi
ghway speed, but then we can let up on the gas pedal and still cruise at the sam
e speed.
Intratrend ADX Strength Rule
Higher ADX peaks are not required for prices to go higher in an uptrend o
r lower in a downtrend.
ADX IS A LAGGING INDICATOR
ADX is a moving average based on a ratio of two other moving averages (+DMI, -DM
I). Moving averages always lag price action and ADX will always lag the signals
we see for price. At the tops and bottoms of trends, ADX will give a late signal
for the trend reversal. But ADX is not meant to be used for entry/exit signals.
Price and DMI are used for our entry/exit signals, and the DMI lines will always
lead ADX. Price is the ultimate "indicator," and when we study ADX, we must do
so in relation to what price is telling us. One of the reasons I use the (13, 8)
settings for my charts is ADX becomes more sensitive and provides better moment
um signals than the default settings.
ADXcellence
ADXplained 61
Figure 4.8 NOV~Weekly (Source: eSignal. www.eSignal.com)
This chart of NOV shows a strong breakout in early 2004 with an ADX that rose to
50. Price then made a series of three higher highs while ADX made a series of t
hree lower highs. This demonstrates how higher ADX peaks are not necessary for p
rices to make higher highs.
The first three ADX peaks register 25 or better. The last ADX peak is weak, bare
ly at 25. When ADX peaks reach the 25 level, the trend will either consolidate a
nd continue, or reverse. The dominant DMI may reassert itself for continuation,
or the bottom DMI may gain dominance and a trend reversal can occur.
When ADX drops below 25 in a trend, the trader should consider taking profits or
tightening stops. Periods where ADX is under 25 do not yield good profits for a
trend trade because the trend lacks adequate strength to make much progress.
ADXcellence
62 Chapter 4
Figure 4.9 NOVWeekly (Source: eSignal. www.eSignal.com)
Figure 4.9 is a continuation from Figure 4.8. The falling ADX peaks noted in Fig
ure 4.8 are shown by the ADX trendline. When ADX drops near 25, the trend will c

onsolidate and continue, or reverse.


Here we see an example of the +DMI reasserting its dominance in January/February
2005. ADX make a new high near 50. Price goes on to new highs, showing continua
tion of the trend.
Note that the last ADX peak in September 2005 is about the same strength as the
new ADX high peak from January/February. This is another example of how a higher
ADX is not required for prices to make higher highs in an uptrend.
ADXcellence
ADXplained 63
Figure 4.10 SPY1 Minute (Source: eSignal. www.eSignal.com)
ADX works great for intraday power trends too. The principles are the same, only
the timeframe is different. This is a chart of the SPY on a 1 min chart.
ADX was below 25 and price was moving sideways before breaking out into a downtr
end. Price crossed below the trendline well before the trend strength rose above
25. This demonstrates the lagging nature of ADX.
The entry is always made with price and DMI; ADX follows for confirmation. Just
after 12:00 p.m., note how the -DMI crossed above +DMI even before price crossed
the trendline. The -DMI gave an early directional signal, and ADX turned up.
ADXcellence
64 Chapter 4
Figure 4.11 FCXDaily (Source: eSignal. www.eSignal.com)
ADX is especially lagging in V-type reversal patterns. In V-type reversals, pric
e does not undergo a period of consolidation before changing directions. FCX is
an example of a V-type downtrend reversal.
Price made a low in mid May and turned up. The ADX declined and fell under 25 at
the end of May when the downtrend ended abruptly and changed to an uptrend.
ADX during V-type reversals is difficult to interpret because both bullish and b
earish forces are strong and in flux. Despite prices reversing up in May, the AD
X did not return to above 25 again until mid July, two months later.
ADXcellence
ADXplained 65
POSITIVE AND NEGATIVE ADX PEAKS
ADX is nondirectional, so an ADX peak due to a downward price swing looks simila
r an ADX peak from an upward price swing. Since prices generally swing up and do
wn in a trend, it is important to sort out the peaks to gain the clearest pictur
e of overall price action. The first step in evaluating ADX waves is to distingu
ish between positive ADX peaks (+ADX) and negative ADX peaks (-ADX).
While both +DMI and -DMI are represented by the ADX line, the dominant DMI repre
sents trend direction and is most responsible for the ADX peak.
The +ADX peaks are recorded when the +DMI is dominant; the -ADX peaks are record
ed when the -DMI is dominant. I call this "sorting out the peaks." Sorting out t
he peaks is important for distinguishing trend legs from retracements and revers
als.
For example, during an uptrend, the +ADX peaks represent upward trend swings. Sm
all retracements are usually represented by a declining ADX line, forming the tr
oughs between the +ADX peaks. During deeper retracements, the ADX line will decl
ine less, and a -ADX peak will form.
When there is no dominant trend, ADX peaks will often alternate between positive
and negative. The more changes in positive and negative ADX peaks, the choppier
the price action. This pattern is seen in highly volatile stocks moving within
a wide range.
When ADX is below 25, the peaks are weak, and sorting them out is less useful. I
t is best to wait until a new ADX peak forms above 25 to give a clear signal of
direction.
The trend of the peaks is important. A series of declining +ADX peaks means the
uptrend is weakening. A series of declining -ADX peaks means the downtrend is we
akening. Strong trends will record several peaks of the same type before a deep
retracement.
ADXcellence
66 Chapter 4

Figure 4.12 AHCDaily (Source: eSignal. www.eSignal.corrO


Strong trends record multiple peaks of the same type (+ADX for uptrends, and -AD
X for downtrends).
Here we see a strong uptrend with ADX remaining well above 25 from June, 2005, o
nward. Notice that a series of three major +ADX peaks are recorded before price
makes a correction and records the -ADX peak in October.
The pattern of three +ADX peaks followed by a -ADX (corrective) peak is common i
n well established trends. Elliott Wave followers will recognize this pattern as
the five wave sequence (motive wave) with three waves in the direction of the t
rend.
ADXcellence
ADXplained 67 Figure 4.13 APC
Daily (Source: eSignal. www.eSignal.com)
{APC - AHADARKO PETE CORP,D) Dynamic,0:00-24:00
Sideways Price
+ADX
Copyright 20fjl cSignal.
75.00
70.00
65.00
60.00
55.00
53.28
Hard to interpret ADX peaks when ADX is <25
27.04
20.82
22 29 5
5

12

20 26 2
9
17 23 1
8
15 22 29
12 19 26 3 10 17
2004
Feb
Mar
A
pr
May
When ADX peaks are below 25, they are less useful for interpretation because of
the lack of trend. However, the mere fact they are below 25 can be important.
This daily chart of APC shows a strong +ADX peak in December of 2004.
Then price went sideways, ADX fell below 25, and the DMI lines crisscrossed each
other. This shows how ADX peaks should be ignored when ADX is less than 25. It
is not until a +ADX peak forms above 25 (as seen in mid-April) that we try to so
rt out the peaks. In this case, the chart tells us the +ADX peak in April was no
t as strong as the +ADX peak in December, 2004an example of relative ADX strength
which is covered in the next section.
The ADX helps in money management since "time is money." During the low ADX peri
od from February to May, a trader does not use a power trend strategy. However,
if the trader owned the stock, they might be fine collecting a dividend; or they
might sell covered calls and collect premium.
ADXcellence
68 Chapter 4
Figure 4.14 UTHRWeekly (Source: eSignal. www.eSignal.com)
This weekly chart of UTHR is a good example of a power trend with windfall profi
ts.
The +ADX peak in 2003 was followed by a period of consolidation where ADX remain
ed below 25 for about ten months. Note how +DMI remained dominant during the con
solidation, and the bias was for continuation of the uptrend.
During low ADX periods, it is better to avoid power trend strategies. Partial pr
ofits might be taken. Positions can be added to on a new breakout.
ADXcellence
ADXplained 69
RELATIVE ADX STRENGTH
Deciphering ADX waves is much easier if a trader understands the concept of rela
tive ADX strength. Relative ADX strength involves the comparison of nearby ADX p
eaks (height) to gain insight into trend momentum. It is helpful when comparing

ADX peaks within a trend as well as peaks between a trend and countertrend.
We are always concerned that an apparent retracement could be a trend reversal o
r that a trend is weakening and ready to reverse. Relative ADX strength is only
a guideline and it must be placed in the context of actual price action; but it
will help the trader read price action much better and prepare for the next move
.
ADX Relative Strength Rule
A lower ADX high (greater than 25 and divergent with price) is a warning
of a trend retracement; a lower ADX high (less than 25 and divergent with price)
is a warning of a trend reversal.
In an uptrend, a lower +ADX peak means the trend is weakening; however, strong u
p trends frequently rise on lower +ADX peaks. If price makes a higher high and +
ADX records a lower peak under 25, it is a warning the uptrend may reverse.
In a downtrend, a lower -ADX peak means the trend is weakening; however, strong
downtrends frequently fall on lower -ADX peaks. If price makes a lower low and ADX records a lower peak under 25, it is a warning the downtrend may reverse.
When ADX is divergent with price, but the ADX is above 25, it is a warning of a
trend retracement, and the DMI lines must be watched more closely for signs of a
change in dominance.
ADXcellence
70 Chapter 4
Figure 4.15 AYEDaily (Source: eSignal. www.eSignal.com)
(AYE - ALLEGHENY ENERGY INC,D} Dynamic,0:
Weak +ADX Peak is a Warning;
30.00
2332
28.00
26.00
24.00
23 316
13 20 27 5 11
18 25 1 8 15 22 29 6 12
19 26 3 10
17 24 31 7
14 2128
Jun
Jul
Aug
Sep
Oct
Nov
Detf\
The daily chart of AYE is an example of ADX relative strength and a warning of a
reversal.
In July, August, and September, price made higher highs and +ADX recorded strong
positive peaks above 25.
Price made a higher high in September and an equal high in October (double top).
On the October price peak, +ADX recorded a relatively weak peak with a value un
der 25. This was a warning the trend strength on the second top was weak and div
ergent with price.
Notice how the +ADX relative strength warning suggested a potential reversal, an
d the warning came before prices crossed the trendline and dropped.
ADXcellence
ADXplained 71 Figure 4.16 WEND
aily (Source: eSignal. www.eSignal.com)
(WEN ; WENDYS INTL INC,D) Dynamic,0:00-24:00
jntratrend ADX Relative Strength iWarnings
38.00
26 3 10 17 24 1 7 14 21 28 6 12 19 26 2 9 16 23 30 7 13 20 27 4 11 18 25 May
Jun
Jul
Aug
Sep
Oct
This chart is an example of an ADX Relative Strength warning in a downtrend. Rem
ember, ADX is nondirectional, so divergence in a downtrend is represented by an
equal or lower low in price, and a lower high in -ADX.
1. Price makes a lower low while ADX makes a lower -ADX high (divergence) ab
ove 25. A trader should follow price closely, tighten stops, and pay attention.
2. Price makes a lower low and -ADX is below 25 and divergent again. This is
the reversal warning, and the divergence pattern is stronger.
Now look at the next chart, Figure 4.17.

ADXcellence
72 Chapter 4
Figure 4.17 WEN Daily (Source: eSignal. www.eSignal.com)
(WEN : WEHOYS INTL INC,D) Dynamic,h00:24:00
42.00 40.95
40.00 39.222
38.00
36.00
34.00
(1)
Copyright O 2004- eSignal.
This chart shows the result of the trend reversal warning in Figure 4.16.
The reversal warning resulted in a trend reversal. Price bounced off the lows in
October and began a strong uptrend with ADX rising above 25.
ADX relative strength provides us with a way to measure the strength of price sw
ings and can help us see price patterns more clearly. However, ADX divergence is
only a warning.
Do not anticipate trend reversals. Use the warning as information to better mana
ge risk. Wait for the trend to reverse before reversing your directional bias.
ADXcellence
ADXplained 73
The concept of ADX relative strength can also be applied to "opposite" ADX peaks
when they are part of a countertrend retracement. A +ADX peak is the opposite o
f a -ADX peak, and a -ADX peak is the opposite of a +ADX peak.
In an uptrend, a -ADX retracement peak can be compared to the preceding +ADX pea
k. In a downtrend, a +ADX retracement peak can be compared to the preceding -ADX
peak. ADX relative strength gives the trader insight into trend/countertrend dy
namics.
A trader must understand the underlying trend dynamics in order to apply ADX rel
ative strength. A -ADX peak in an uptrend usually means a complex countertrend r
etracement (down); likewise, a +ADX peak in a downtrend usually means a complex
countertrend retracement (up).
In contrast, simple retracements cause the ADX line to decline, but ADX usually
does not form an opposite peak. Simple retracements retest at the 20 EMA and set
up entry opportunities because there has been no change in DMI dominance.
In an uptrend, a lower -ADX countertrend retracement peak usually leads to conti
nuation of the uptrend. In a downtrend, a lower +ADX countertrend retracement pe
ak usually leads to continuation of the downtrend.
Countertrend ADX Relative Strength Rule
In an established trend, a lower countertrend ADX peak usually l
eads to continuation of the trend.
Retracements tend to alternate between simple and complex. In strong trends, don
't assume the trend is going to reverse after a complex retracement. Retracement
is more likely than reversal; reversals are more likely to follow some form of
trend climax.
ADXcellence
74 Chapter 4
Figure 4.18 MCHPDaily (Source: eSignal. www.eSignal.com)
The chart of MCHP is an example if ADX relative strength applied to a countertre
nd.
The +ADX peak in February is strong and corresponds with uptrending prices. Pric
e then enters a countertrend (down), making lower lows and lower highs.
In April, prices bottom on a relatively weaker -ADX when compared to the previou
s +ADX. Since the countertrend -ADX was weaker our bias is for prices to resume
the uptrend. Prices continued up in May with a new +ADX high.
A trader may look for a place to add to a position or enter a new position if pr
ice begins a new uptrend leg.
ADXcellence
ADXplained 75

Figure 4.19 SLBDaily (Source: eSignal. www.eSignal.com')


Here is an example of both types of ADX relative strength.
The two +ADX peaks in July and August are represented by rising prices in an upt
rend. However, the second peak in August is divergent with price. Rising prices
on relative +ADX weakness is a form of bearish divergence; and, as we can see, p
rices entered a retracement.
In October, we see a -ADX peak because it was a deep retracement. The -ADX peak
is relatively weaker than the last major +ADX peak in August. Our bias is for pr
ices to resume the uptrend. That is exactly what happened and we see a higher +A
DX peak (above 25) in November, telling us the bulls were back in control.
ADXcellence
76 Chapter 4
TRENDLINES ON ADX
Trendlines can be drawn on ADX to provide a better picture of trend consolidatio
ns and reversals. The important thing is to always draw the trendline on top of
same type peaksall +ADX peaks for uptrends or all -ADX peaks for downtrends. Find
ing trend reversals with ADX trendlines is a lagging signal, but it does help th
e trader see the potential for a reversal. Use -ADX peaks to see downtrend rever
sals and +ADX peaks to see uptrend reversals.
Price is in a downtrend from October to the end of December, 2004. The +ADX peak
in October is not used for drawing the trendline, because we use -ADX peaks to
find downtrend reversals. There are three -ADX peaks upon which the trendline is
drawn. In early February, 2005, ADX broke above its down trendline confirming t
he price breakout in later January.
ADXcellence
ADXplained 77 Figure 4.21
WPIWeekly (Source: eSignal. www.eSignal.com')
Sep Nov Jan Mar May JulAug Oct Nov Jan Feb Apr May Jul
_______________2003___________________________
2004
(WPI r WATSON PHARMACEUTICALS INC.W)
50.00
45.00
40.00
Falling +ADX Peaks
Directional Movement(13,8)
This is an example of using a trendline on +ADX peaks to help see the uptrend re
versal.
Whenever a divergent ADX peak falls below 25 be watchful of a reversal. Watch pr
ice and DMI for early signals. Use ADX for confirmation.
ADXcellence
78 Chapter 4
ADXcellence
SECTION TWO
POWER TREND PRINCIPLES
ADXcellence
80
ADXcellence
CHAPTER 5
Power Trend Dynamics
Trend is the most basic and important concept in trading; all trading is based o
n trend or the lack of trend. An understanding of trend dynamics is essential fo
r consistent trading success, no matter what indicators are used.
Trend dynamics are important because they give structure to price action, provid
ing a context for applying trading strategies. Understanding how trends are cons
tructed is more important than any indicator or trading system.
All of the power trend strategies in this book are based on trend. Using ADX/DMI
with power trends is the perfect combination for a trading system. The basic di
scussion of trend which follows is meant to complement the ADX/DMI principles an
d strategies presented in this book.
Be sure you understand the concept of price pivots and what constitutes a pivot

reversal. Pivots designate areas of support and resistance and serve as entry pr
ice "triggers" for power trend strategies.
ADXcellence
82 Chapter 5
PIVOTAL CONCEPTS
Each day, price action is recorded as a price bar. The bar has an open, high, lo
w, and close. When a series of price bars reverses direction, we call it a price
pivot. The pivot is composed of a minimum of three bars.
A pivot low is formed by a price bar with bars on each side having higher lows.
A pivot high is formed by a price bar with bars on each side having lower highs.
This three-point structure is the building block of all trends. Entries for pow
er trend strategies are made on pivot highs and lows.
Figure 5.1
The two diagrams in Figure 5.1 above show the two basic pivot reversals. For the
pivot low (left), the horizontal line represents the high of the middle bar whi
ch must be exceeded to complete the pivot. The high of the middle bar represents
the long entry price on a pivot low reversal (up).
For the pivot high (right), the horizontal line represents the low of the middle
bar which must be exceeded to complete the pivot. The low of the middle bar rep
resents the short entry price on a pivot high reversal (down).
ADXcellence
Power Trend Dynamics 83
Figure 5.2 QQQQWeekly (Source: eSignal. www.eSignal.com)
Above is a weekly chart of the QQQQ with three short-term pivots. From left to r
ight, there is a pivot high, a pivot low, and another pivot high. The horizontal
lines represent the reversal (entry) points. Pivot lows reverse by making a new
daily high. Pivot highs reverse by making a new daily low.
TRENDLINES
Pivots are used for drawing trendlines. A pivot low is an area of support where
demand overcomes supply. A pivot high is an area of resistance where supply over
comes demand. For uptrends, the trendline is drawn on the pivot lows. For a down
trend, the trendline is drawn on the pivot highs. Trendlines drawn on both pivot
highs and lows creates a trend channel. During consolidation periods, trendline
s frame out chart patterns.
The slope of a trendline represents the speed of the trend. Trendlines also repr
esent a line of support and resistance. When price crosses a trendline, it is of
ten an early sign of a trend reversal or retracement. When a support trendline i
s crossed it becomes resistance; when a resistance trendline is crossed is becom
es support.
ADXcellence
84 Chapter 5
Figure 5.3 OXYWeekly (Source: eSignal. www.eSignal.com)
In uptrends, the trendline is drawn on the short-term pivot lows to define the i
ntermediate-term trend. After a deep retracement, another trendline can be drawn
on the intermediate-term pivot lows to define the long-term trend (not shown).
In general, be long above the trendline and place a stop-loss below the trendlin
e.
ADXcellence
Power Trend Dynamics 85
Figure 5.4 UISWeekly (Source: eSignal. www.eSignal.com)
In downtrends, the trendline is drawn on the short-term pivot highs to define th
e intermediate-term trend.
Price has memory and often revisits the trendline. After the big drop in price i
n July, 2004, price revisited the trendline in November, 2005.
In general, be short below the trendline and place a stop-loss above the trendli
ne.
ADXcellence
86 Chapter 5
TREND STRUCTURE
Timeframes present one of the hardest concepts for traders to understand and us

e in their trading strategies. Trends are the movement of price through time, an
d price will trend differently in different timeframes. A major edge in trend tr
ading comes from understanding how trends on different timeframes relate to one
another.
We commonly refer to three types of trends based on both their timeframe and st
ructure.
Figure 5.5
Trend
Time Period
Structure
Short-term (ST)
Days to weeks Daily Bars
Intermediate-term (IT) Weeks to months ST Pivots
Long-term (LT)
Months to years IT Pivots
Short-term trends are structured with daily bars and last a few days to about t
wo weeks. Intermediate-term trends are composed of short-term pivots and last a
few weeks to a few months. Long-term trends are structured with intermediate-ter
m pivots and last from months to years. The structure of the three timeframes is
concrete but the time periods will vary somewhat.
Conceptually, the best power trends will set up on the long-term timeframe beca
use they have the potential to run for months to years. The long-term timeframe
is represented by a weekly chart. Daily charts are best for seeing the intermedi
ate-term trend and trades can last several months. Short-term trends are for swi
ng traders and not trend traders.
It is important to understand how trends can be different on different timefram
es and how they relate to one another. For instance, a long-term uptrend that un
dergoes a deep retracement on a weekly chart can be represented by a downtrend o
n a daily chart.
ADXcellence
Power Trend Dynamics 87 Figure 5.6 YH
OODaily (Source: eSignal. www.eSignal.com)
All three trends are shown in this daily chart of YHOO. The long-term trend is c
omposed of intermediate-term trends and the intermediate-term trend is composed
of short-term trends. Short-term trends are composed of daily bars.
This same trend "structure" can be seen on all timeframes.
ADXcellence
88 Chapter 5
Figure 5.7 ADMDaily (Source: eSignal. www.eSignal.com')
This daily chart of ADM demonstrates the crosscurrents that occur in trends.
The long arrow shows the prevailing trend which is clearly up. But the smaller a
rrows pointing down show short-term prices trending down, not up. The downtrend
areas are retracements in a larger uptrend structure.
ADXcellence
Power Trend Dynamics 89
Building with Pivots
Pivot highs and lows allow us to build four basic patterns of price. When pivot
s highs and lows move in the same direction they form trends. When pivot highs a
nd lows move in the opposite direction they form price patterns.
Figure 5.8 Pivot Combinations
PIVOT HIGHS PIVOT LOWS PRICE PATTERN
Higher
Higher
Uptrend
Higher
Lower
Broadening Formation
Lower
Higher
Triangle
Lower
Lower
Downtrend
Figure 5.9 Uptrend
An uptrend is a series (two or more) of higher pivot highs and higher pivot low
s.
ADXcellence
90 Chapter 5
Figure 5.10
A broadening formation is a series of higher pivot highs and lower pivot lows an
d represents high volatility consolidation.
Figure 5.11 Downtrend

A downtrend is a series of lower pivot highs and lower pivot lows.


ADXcellence
Power Trend Dynamics 91
A triangle is a series of lower pivot highs and higher pivot lows and represents
low volatility consolidation.
Trends alternate between periods of range expansion and range contraction. Durin
g range expansion, prices trend. During range contractions, prices consolidate.
During consolidation periods, bullish uptrend and bearish downtrend forces are n
early equal, preventing prices from trending in one direction; and buyers and se
llers test each other to agree on price. Eventually, one side wins out and price
s begin a new trend.
When prices make a series of lower highs and higher lows, we have range contract
ion and a sideways trend. As range contracts, the price swings get smaller and s
maller. This situation is represented by the common triangle pattern. The triang
le is the main power trend pattern to look for and trade using the breakout stra
tegies presented later in the book.
When price make a series of higher highs and lower lows, we have range expansion
and a sideways trend. This situation is represented by the broadening formation
. As range expands, the price swings get wider and wider. These patterns are not
for trend trading, but swing traders can make short-term trades off the support
and resistance levels until there is a clear trend direction.
ADXcellence
92 Chapter 5
From Bars to Trend
In this section, we will build a trend from three bars to a long-term trend. Thi
s exercise is meant to review trend structure and solidify your understanding of
trend dynamics.
This diagram shows four bars, three of which form a short-term pivot low and mar
k the beginning of a short-term uptrend.
Figure 5.14
This diagram shows the next level, a series of higher short-term lows and higher
short-term highs which compose an intermediate-term trend.
ADXcellence
Power Trend Dynamics 93
This diagram shows the next level of a trend, a long-term uptrend composed of hi
gher intermediate-term highs and lows.
Let's review the building blocks of a trend:
For Uptrends:
a short-term uptrend is a series of higher daily highs and higher daily low
s
an intermediate-term uptrend is a series of higher short-term highs and hig
her short-term lows
a long-term uptrend is a series of higher intermediate-term highs and highe
r intermediate-term lows
For Downtrends:
a short-term downtrend is a series of lower daily highs and lower daily low
s
an intermediate-term downtrend is a series of lower short-term highs and lo
wer short-term lows
a long-term downtrend is a series of lower intermediate-term highs and lowe
r intermediate-term lows
Trend structure is hard, so just keep thinking in these terms and eventually it
will sink in. When it does, your market vision will improve greatly.
ADXcellence
94 Chapter 5
Trend Reversals
Many traders place emphasis on finding and trading trend reversals. But trend re
versals are usually high risk and low reward. The important thing about reversal
s is to recognize when they have occurred, so trades can be exited if needed; an
d trend trading strategies can be applied in the new direction.

Trends usually do not reverse without warning. Even the climax reversal is a for
m of warning because it will have wide range bars without much overlap and a ste
eper trend slope. Anticipating trend reversals is a swing trading strategy, not
a trend trading strategy, although a swing trade can turn into a trend trade und
er the right conditions.
Usually, trends take time to reverse. The supply and demand imbalance that creat
ed the trend must stop, find equilibrium, and create a new imbalance in the oppo
site direction. Traders must unwind positions and/or enter new ones. While this
process goes on, capital is best used for active trends. The best risk/reward is
an entry at support/resistance after the trend has confirmed a reversal.
For power trend trading with ADX/DMI, wait for trends to reverse. I especially p
refer trading reversals after they have consolidated long enough to make a big r
un. Consolidations at tops of trends (distribution) will give breakout opportuni
ties for downtrends. Consolidations at bottoms of trends (accumulation) will giv
e breakout opportunities for uptrends.
It is important to recognize when a trend reverses. A trend reverses when a seri
es (two or more) of pivots trend in the opposite direction. In a downtrend, we h
ave a series of lower highs and lower lows. Once we see a series of higher lows
and higher highs, the trend has changed to an uptrend. Conversely, in an uptrend
, once we see a series of lower highs and lower lows, the trend has changed to a
downtrend.
ADXcellence
Power Trend Dynamics 95
Figure 5.16 shows one way an uptrend can reverse. Notice the lower low (1), foll
owed by a lower high, then another lower low (2). The trend reverses on the seco
nd lower low.
Figure 5.17 shows one way a downtrend can reverse. Notice the higher high (1), f
ollowed by a higher low, then another higher high (2). The trend reverses on the
second higher high.
ADXcellence
96 Chapter 5
Figure 5.18 FDDaily (Source: eSignal. www.eSignal.com)
This chart is an example of an intermediate-term uptrend that makes a reversal t
o an intermediate-term downtrend. The trend reverses on a down cross of the hori
zontal trendline when price makes a lower low.
1. Price makes a lower low, followed by a lower high.
2. Price breaks below horizontal support, making a second lower low; and a d
owntrend follows.
ADXcellence
Power Trend Dynamics 97
Figure 5.19 BBYDaily (Source: eSignal. www.eSignal.com)
This chart is an example of an intermediate-term downtrend that makes a reversal
to an intermediate-term uptrend. The trend reverses on an up cross of the horiz
ontal trendline.
1. Price makes a higher high above the down trendline. Price then drops belo
w the trendline and makes a higher low.
2. Price breaks above horizontal resistance and makes a second higher high,
beginning the uptrend.
ADXcellence
98 Chapter 5
ADX TREND REVERSALS
Tops and bottoms are not an eventthey are a process. One of the power trend tradi
ng principles is to wait for the trend to reverse before entering.
This rule will serve you well, and the few entries you miss (or could have enter
ed earlier) will be far outweighed by the profits you make from solid entries ba
sed on sound trend analysis.
Trends usually consolidate before making a reversal and the low ADX patterns bec
ome breakout trades (covered elsewhere). There are two other ADX trend reversal
patterns that occur without price consolidation; they are important to recognize
(Figures 5.20 and 5.21).

One pattern is a slow, gradual loss of buying or selling momentum, followed by a


cross of the trendline and new highs/lows. The trend exhausts its energy. This
can be seen with ADX by a series of lower ADX highs. ADX falls to 25 or below, t
hen a higher opposite ADX high forms when price crosses the trendline.
The other way is a gradual loss of momentum followed by climax momentum, and fin
ally a cross of the trendline and new pivot highs/lows. This pattern can be seen
with ADX making a series of lower ADX highs, followed by a higher ADX of the sa
me type.
The higher ADX high is the final "exclamation point" of the trend and represents
the final price surge. After the climax ADX wave, prices reverse quickly, and a
n opposite ADX high forms when prices break through the trendline.
ADXcellence
Power Trend Dynamics 99
Figure 5.20 PARLDaily (Source: eSignal. www.eSignal.com)
This is an intermediate-term uptrend with weakening strength as shown by lower h
ighs in +ADX. When price crosses the trendline and makes new lows, we see a risi
ng -ADX that makes a new high.
No price climax is evident, and the reversal is symmetrical, forming an inverted
cup pattern. Conceptually, this represents a perfect example of a gradually wea
kening trend, eventually resulting in a reversal.
ADXcellence
100 Chapter 5
Figure 5.21 NATWeekly (Source: eSignal. www.eSignal.com~)
This is a climax pattern. We first see weakening of the trend when +ADX fails to
make a new high in July, 2004. ADX then makes a lower high in October, 2005, wh
ile price makes a higher high (divergence)
Just when we think the trend is weak (ADX < 25) and might reverse, we get one fi
nal push in price that registers a higher +ADX peak. This is the climax.
The final phase is a -ADX peak which is the start of the trend reversal. Notice
how price drops below the trendline just after the last +ADX peak in February, 2
005.
The ADXclamation Point pattern can be used to look for entries after the trend re
versal.
ADXcellence
CHAPTER 6
Power Trend Momentum
ADX and DMI are momentum oscillators and can be used as both trend and momentum
indicators. This chapter will present momentum concepts and show that powerful m
omentum is behind all power trends.
Momentum is the velocity of price and trend momentum is the velocity of a trend.
Strong momentum underlies strong trends. Both ADX and DMI demonstrate momentum
characteristics and provide us with excellent signals for trading.
Momentum principles are a major key to understanding trend progression. ADX show
s us the overall momentum of the trend while DMI exhibits the momentum of price
swings within the trend. When used together, ADX and DMI comprise a powerful ind
icator that measures trend strength, direction, and momentum.
ADXcellence
102 Chapter 6
TREND MOMENTUM
Trend momentum is the velocity of the overall trend and is measured by the seque
nce of ADX peaks. With momentum, we compare the relative height of the ADX peaks
when they are above 25.
If the peaks are getting higher, the trend momentum (strength) is increasing; if
the ADX peaks are getting lower, the trend momentum (strength) is decreasing.
Patterns of momentum vary greatly between stocks. However, ADX is excellent for
showing us four basic patterns of trend momentum:
1. Uptrend with strengthening momentum
2. Uptrend with weakening momentum
3. Downtrend with strengthening momentum
4. Downtrend with weakening momentum

The momentum concepts are more important than the actual patterns since much of
the time price does not give us perfect patterns. In general, strongly trending
markets tend to give 2-3 ADX peaks (15-30 bars apart) per timeframe before enter
ing a correction.
As long as the trend momentum is increasing, we can expect the trend to continue
. The exception is the ADXclamation Point pattern (see Chapter 5, pg. 100) where
a stronger momentum surge precedes a trend reversal.
ADX Trend Momentum Rule A higher ADX high (except in a climax
pattern) usually leads to a retest of highs in both price and ADX.
ADXcellence
Power Trend Momentum 103
Figure 6.1 ESRXDaily (Source: eSignal. www.eSignal.com)
ESRX is in an uptrend. Notice that each ADX peak gets progressively higher as pr
ice steadily rises. This is an example of momentum convergence, or confirmation.
Momentum agrees with price.
As long as the ADX peaks get higher and higher, a trader can hold their stock an
d add to their position by entering on pullbacks. Trends tend to travel farther
than we think, so the ADX Trend Momentum Rule helps us stay in the best power tr
ends.
ADXcellence
104 Chapter 6
Figure 6.2 PFGDaily (Source: eSignal. www.eSignal.com)
Uptrend With Weakening Momentum
PFG demonstrates a weakening uptrend. The three ADX peaks are getting progressiv
ely lower. Weakness does not mean the trend will reverse. It is a warning of a p
otential retracement or reversal. Often, weakening momentum results in a consoli
dation period, after which the trend resumes.
ADXcellence
Power Trend Momentum 105 Figure 6.3 PFED
aily (Source: eSignal. www.eSignal.com)
23.2271
Directional Movement(14,14}
- PFIZER INC,D) Dynamic,0:00-24:00
Copyright O 2004 eSignal.
Downtrend With Strengthening Momentum
PFE is in a downtrend. Here is another example of how ADX is nondirectional. Not
ice the ADX peaks are getting higher, but price is going lower. The downtrend is
strengthening.
The gap down is suggestive of an exhaustion gap often seen at climaxes. Notice h
ow the trend has three main waves, a common pattern before a consolidation or re
versal.
ADXcellence
106 Chapter 6
Figure 6.4 MASDaily (Source: eSignal. www.eSignal.com)
Downtrend With Weakening Momentum
MSC is in a downtrend which can be seen by falling prices. ADX is also falling,
telling us that the downtrend is weakening.
ADXcellence
Power Trend Momentum 107
ADX MOMENTUM DIVERGENCE
ADX divergence is a form of nonconfirmation. Anytime price makes a higher swing
high in an uptrend, but ADX makes a lower high, there is bearish divergence. Any
time price makes a lower swing low in a downtrend, but ADX makes a lower high, t
here is bullish divergence.
Divergence is NOT a signal for a trend reversal. It is a warning that price is a
dvancing or declining on lower trend strength. ADX divergence tells the trader t
o pay attention when price makes the next test of support/resistance. Trend reve
rsals and retracements can follow ADX divergence.
MOMENTUM RETRACEMENTS
Complex retracements frequently alter the ADX trend pattern because they mix +AD

X and -ADX peaks within a trend. ADX normally declines during a simple retraceme
nt and rises again on the next swing in the trend. In contrast, deep (complex) r
etracements will often register an opposite ADX peak.
For instance, after two +ADX peaks in an uptrend, a deep retracement can make a
-ADX peak before we see another +ADX peak. Likewise, a downtrend retracement wil
l often make a +ADX peak before we see another -ADX peak. Understanding the ADX
retracement pattern can keep the trader oriented with the dominant trend.
The key to understanding retracements is to sort out the peaks. First identify t
he +ADX peaks in an uptrend or the -ADX peaks in a downtrend. Next, study the AD
X peak that forms during the retracement. Is it an opposite ADX peak? Is it high
er or lower than the ADX peak before the retracement? Studying the relative stre
ngth of the ADX peaks usually gives the trader more information than can be seen
by price alone.
Deep retracements often look like, or meet criteria for, a trend reversal. Looki
ng at the ADX pattern will help clarify the likely future direction of price. Wh
enever there is a question concerning the ADX pattern, studying the ADX pattern
on a higher timeframe will add additional insight.
ADXcellence
108 Chapter 6
Figure 6.5 PETSWeekly (Source: eSignal. www.eSignal.com)
(PETS - PETMED EXPRE SS INC.W) Dynamic,0:00-24:00
14.00
12.00
10.00
8.00
6.88
6.00
4.00
2.00 75 50
26.54
** ** 14.68 0
Higher Price High
u
in
nt
.f
Jr!
Bearish ADX Divergence
H
Apr May JunJul Aug
Oct Nov Jan Feb Apr JunJul Aug Oct Dec
2004
This is a weekly chart of PETS shows a bearish divergence in February of 2005 wh
ich led to a trend reversal. While price made a higher high in February, +ADX ma
de a lower high. This is a warning the trend is weaker than it might look when v
iewing price alone; and prices may be setting up or a reversal or retracement.
ADX divergence is common before a trend retracement. When a trader sees divergen
ce, they should consider tightening stops or taking off part of their position.
It is important to let profits run, but ignoring divergence signals can lead to
unnecessary losses.
ADXcellence
Power Trend Momentum 109 Figure 6.6 HDWe
ekly (Source: eSignal. www.eSignal.com)
This weekly chart of Home Depot (HD) shows a downtrend in late 2002. In February
of 2003, price made a lower low while -ADX made a lower high. This is a good ex
ample of bullish ADX divergence in a downtrend.
Divergences are not as common at bottoms as they are at tops. Panic is greater a
t bottoms and the final lows tend to climax. Climaxes usually show higher moment
um on ADX which agrees with price. Frequently, the last low of a downtrend is th
e strongest and -ADX makes a higher high just before a reversal or consolidation

period.
ADXcellence
110 Chapter 6
Figure 6.7 CMCWeekly (Source: eSignal. www.eSignal.com)
ADX divergence is common before a trend retracement. CMC shows an established up
trend which developed bearish ADX divergence in late February, 2004. The diverge
nce led to a retracement, but not a trend reversal.
The ADX peak at the April low is a -ADX peak, and -DMI challenged for dominance
but made a "failure cross." The +DMI quickly took back control.
The -ADX peak at the April low is lower than the last +ADX peak before the retra
cement. This usually means prices will resume the underlying trend.
ADXcellence
Power Trend Momentum 111
Figure 6.8 ISRG Daily (Source: eSignal. www.eSignal.com)
ISRG was in a strong uptrend before September at which time the stock entered a
retracement. ISRG broke out again in November. Notice during the retracement the
-DMI failed to be strong enough to create a -ADX peak.
When no opposite ADX peak registers in a retracement, prices are more likely to
continue in the direction of the trend. The failure to make an opposite ADX peak
agrees with the sideways price movement.
ADXcellence
112 Chapter 6
This is an example of a -ADX peak during an uptrend retracement. LM is in a week
ly uptrend until April of 2004 where it enters a retracement. Notice the retrace
ment follows a lower +ADX high (divergence).
During the retracement, a -ADX high forms (-DMI gains dominance). But the -ADX h
igh is lower than the previous +ADX high. The trend continues upward in October
of 2004. This is a good example of the Countertrend ADX Relative Strength Rule (
Chapter 4, pg. 73).
ADXcellence
Power Trend Momentum 113
Figure 6.10 CHS Weekly (Source: eSignal. www.eSignal.com)
CHS is another example of an opposite ADX peak during a retracement. The uptrend
records a lower +ADX high (divergence), then the stock enters a retracement. Du
ring the retracement, we see a lower -ADX high. Price then resumes its uptrend w
ith a higher +ADX high (relative to the -ADX peak).
A trend can always enter further consolidation rather than continue. Or it could
continue lower and complete a reversal. ADX will give the clues, and DMI will p
rovide early signals if there is a change of DMI dominance. In the chart above,
-DMI gains dominance briefly, then +DMI takes over again.
ADXcellence
114 Chapter 6
DMI MOMENTUM
Trend momentum is our bigger picture, and it is measured by ADX. The DMI lines a
re used for momentum on price swings. Integrating the DMI lines into the larger
context of ADX is how power trends are found and traded. Used properly, the DMI
lines tell us much more than simply trend direction.
In the following sections, I will cover momentum concepts for price and DMI swin
gs. The DMI lines are range indicators; therefore it is helpful to think of them
as indicators for range momentum rather than simply price. New trends begin wit
h range expansion, and DMI is excellent for showing range breakouts. DMI is also
used to read momentum divergences with price.
DMI CONFIRMATION AND NONCONFIRMATION
Confirmation (convergence) occurs when price and DMI agree. The focus is always
on price, and the DMI lines are used to confirm price. Price never confirms an i
ndicator. DMI confirms price when price makes a new high and +DMI makes a new hi
gh; or when price makes a new low and -DMI makes a new high. When price has conf
irmation, there are much higher odds of trend continuation. Confirmation on cons
olidation breakout trades will help the trader avoid traps and head fakes.
Trigger pivots (discussed in Chapter 3, pg. 33) are an example of confirmation.

For bullish trigger pivots, the +DMI makes a pivot low, followed by a new +DMI h
igh; and price makes a pivot low followed by a new high in price. For bearish tr
igger pivots, the -DMI makes a pivot low, followed by a new -DMI high; and price
makes a pivot high followed by a new low in price.
Nonconfirmation (divergence) occurs when price and DMI disagree. DMI fails to co
nfirm price when price makes a new high, but +DMI fails to make a new high; or w
hen price makes a new low, but -DMI fails to make a new high. Divergence is a wa
rning and leads to a retest of the last price high/low. Divergence is not a sign
al of a trend reversal, although some divergences lead to a reversal.
Confirmation patterns are show in Figures 6.11 and 6.12.
ADXcellence
Power Trend Momentum 115
Breakouts up often retest the resistance trendline; after a successful test, the
resistance trendline becomes support. Breakouts down often retest the support t
rendline; after a successful test, the support trendline becomes resistance.
DMI Breakout Rule (Confirmation)
A valid breakout up requires a new high in price and a new high in +DMI;
a valid breakout down requires a new low in price and a new high in -DMI.
ADXcellence
116 Chapter 6
Nonconfirmation patterns are showing in Figures 6.13 and 6.14.
ADXcellence
Power Trend Momentum 117
Figure 6.15 HUMDaily (Source: eSignal. www.eSignal.com)
HUM is a daily chart with consolidation during the period of February through Ap
ril of 2003 (ADX line not shown). In March, a false breakout occurred.
In mid-April, price made another attempt to breakout and succeeded. It is confir
med by the +DMI which had a breakout above prior +DMI highs. This breakout start
ed a two year uptrend in the stock where the price quadrupled.
This chart emphasizes that traders do not need to predict price to profit consis
tently. They only need to be patient and wait for confirmation of price directio
n and trade with the trend.
Losing traders place too much emphasis on calling direction in the market. Winni
ng traders let price tell them when the direction is changing and then jump on f
or as long as the trade is profitable.
ADXcellence
118 Chapter 6
Figure 6.16 NVDADaily (Source: eSignal. www.eSignal.com)
NVDA entered a period of price consolidation during June, July, and August. Pric
e broke above the upper trendline (resistance) in mid-August. The +DMI confirmed
the breakout by breaking above a trendline drawn on the +DMI peaks.
In late August, price successfully retested the resistance line and it became su
pport. The pullback after a breakout is the best entry from a risk/reward standp
oint.
ADXcellence
Power Trend Momenturn
119
Figure 6.17 BSXDaily (Source: eSignal. www.eSignal.com)
In February, BSX moved sideways and successfully tested support in late February
.
It early March, price dropped below the support level and -DMI made a new high w
hich confirmed the breakout. After a one-day breakout, price retested support an
d continued down. The support line became resistance.
Notice when the price spiked in early February, the +DMI failed to gain dominanc
e. The dominant DMI is our bias for the immediate direction of price.
ADXcellence
120 Chapter 6
Figure 6.18 BUD Daily (Source: eSignal. www.eSignal.com)
BUD traded sideways in December 2005. It broke below support in early January an
d retested support in early February. Price then continued in a downtrend.
There are two things to observe with DMI. First, -DMI made a crossover high indi

cating the dominant direction was down.


We also see a new -DMI high which occurred just before the crossover. This is an
example of how -DMI momentum was increasing before price broke below support. M
omentum precedes price.
ADXcellence
Power Trend Momentum 121
Figure 6.19 BUDDaily (Source: eSignal. www.eSignal.com)
This is another chart of BUD. It consolidated in May and June forming a symmetri
cal triangle. Momentum indicators are not reliable in consolidation patterns and
the direction of the breakout cannot be predicted.
Notice the small swings in DMI during late May and early June. No signal can be
taken from these minor swings. However, the -DMI gave a good confirmation signal
when it made a crossover high as price broke out to the downside.
ADXcellence
122 Chapter 6
ADXcellence
CHAPTER 7
Power Trend Volatility
When we think of volatility indicators, we usually think of Average True Range,
Historical Volatility, and Bollinger Bands. But ADX is an excellent volatility i
ndicator too. In this chapter, ADX volatility patterns are presented to provide
a backdrop from which to choose the best trading strategy.
Volatility is the rate at which price moves up and down. A stock s volatility is
commonly represented as historical volatility, an annualized standard deviation
of daily price movement. However, ADX tells us a great deal about the volatilit
y of a trend simply by looking at the ADX pattern.
Stocks with volatile ADX patterns are often preferred for daytrading because the
y have wide price swings from which to profit intraday. ADX patterns showing hig
h trend strength and low volatility are preferred for power trend strategies bec
ause they have narrower price swings and there is less risk of being stopped out
.
Understanding ADX volatility patterns can help the trader choose the appropriate
trading strategy for volatility conditions. The sections which follow will disc
uss trading strategies and give examples of different types of ADX volatility pa
tterns.
ADXcellence
124 Chapter 7
ADX VOLATILITY
With fixed upper and lower numerical limits, the oscillations in ADX provide us
with a gauge of trend volatility by simply looking at the degree and frequency o
f change in slope of the ADX line. If ADX makes wide, frequent swings, there is
high volatility. If ADX makes narrow, infrequent swings, there is low volatility
.
Trend strength and volatility are related, but they should be interpreted indepe
ndently. One of the keys to understanding ADX patterns is realizing low trend st
rength does not necessarily mean low volatility; likewise, high trend strength d
oes not necessarily mean high volatility. That said, it is much harder to have h
igh volatility with low trend strength because volatility requires some strength
to make wide price swings.
With ADX, a trader can assess both trend strength (ADX value) and trend volatili
ty (changes in slope) at the same time. For example, if ADX is high and swings a
re wide, there is high trend strength and high volatility. If ADX is low and swi
ngs are wide, there is low trend strength and high volatility.
ADX VOLATILITY PATTERNS
ADX will provide the trader with many patterns that combine ADX value, slope, an
d volatility (changes in slope). These patterns do not need to be memorized. The
y are presented as a reference and to provide context for trading strategies.
When looking at ADX patterns, we have three considerations: Is the ADX high or l
ow? Is it sloping up or down? And does it change direction frequently or infrequ
ently?

With this information we can define several ADX patterns. The following examples
are conceptual representations of the ADX line under different trend conditions
along with a representative stock chart.
ADXcellence
Power Trend Volatility 125
Figure 7.1
Figure 7.2 IIJIDaily (Source: eSignal. www.eSignal.com)
ADXcellence
126 Chapter 7
Figure 7.3
Figure 7.4 MOVI Daily (Source: eSignal. www.eSignal.com)
ADXcellence
Power Trend Volatility 127
Figure 7.5
Figure 7.6 WYDaily (Source: eSignal. www.eSignal.com)
ADXcellence
128 Chapter 7
Figure 7.7
Figure 7.8 CELGDaily (Source: eSignal. www.eSignal.com )
ADXcellence
Power Trend Volatility 129
Figure 7.9
Figure 7.10 HANSDaily (Source: eSignal. www.eSignal.com)
ADXcellence
130 Chapter 7
Figure 7.11
Figure 7.12 SAXDaily (Source: eSignal. www.eSignal.com )
ADXcellence
Power Trend Volatility 131
Figure 7.13
Figure 7.14 PRLS Daily (Source: eSignal. www.eSignal.com)
ADXcellence
132 Chapter 7
Figure 7.15
Figure 7.16 SHLDDaily (Source: eSignal. www.eSignal.com~)
ADXcellence
Power Trend Volatility 133
STRATEGIES AND VOLATILITY
One of the things you will find when looking at trend volatility is just how oft
en the character of the trend changes. Trends don t stay in one mode for long be
fore they do something different. Low volatility leads to high volatility, and h
igh volatility leads to low volatility. In reality, trends are not of one type o
r another; they contain different trend and volatility features at different tim
es.
Understanding the volatility conditions is important for trading successfully. C
ertain conditions favor certain types of trades. In general, high volatility fav
ors momentum strategies; low volatility favors trend strategies.
Depending on the phase of the stockaccumulation, markup, distribution, or markdow
nstocks will move through different conditions. The important thing is to recogni
ze the trend and volatility conditions, so an appropriate trading strategy can b
e chosen.
When low volatility occurs with high trend strength, it represents the strongest
type of trend pattern (Figure 7.4). Under these conditions, a trader should est
ablish a position and sit back for the long, slow ride. The chance of being stop
ped out on price swings is low relative to more volatile trends.
When low volatility is present with low trend strength (Figure 7.2), the trend w
ill not support trend trading strategies. In these conditions, you simply wait f
or price to eventually breakout in one direction or the other.
When high volatility occurs with low trend strength, trend trading strategies ar
e risky and the best trades are short-term reversal trades off of support and re

sistance. When trend strength is high and volatility is high, a trader has trend
conditions; but the swings will be wider and a trader will likely want to avoid
holding through retracements.
Figure 7.17 is a table which can serve as a guideline for the types of trades th
at work best in certain conditions. I will give specific strategies later in the
book, but I want you to understand the concepts behind why a particular type of
strategy is chosen for a given ADX pattern.
ADXcellence
134 Chapter 7
Figure 7.17 Conditions and Trade Type
VOLATILTIY TREND
TREND
TRADE
STRENGTH
Low
Low
Little or no trend Watch and
Wait Mode--Breakout
Trades Only
Low
High
Strong trend
Stay with the
trend, trail
your stop
High
High
Strong Swings
Momentum
trades, don t
hold through
retracements
High
Low
Weak Swings
Short-term
trades off
support and
resistance
VOLATILITY AND RISK
The main reason to study volatility conditions is to understand the risk associ
ated with trades. High volatility means high risk, and low volatility means low
risk. Power trend traders who manage risk well and participate in strong trends
will be successful.
Traders who enter trades during high volatility swings will be frequently stopp
ed out on retracements. Traders who enter during low ADX periods will sit and wa
it while nothing happens, and about half the time be stopped out when price brea
ks out in the opposite direction of their trade.
During high volatility the risk is high, and that is why option premiums are al
so high and favor the sell side. In low volatility the risk is low; option premi
ums are cheaper and favor the buy side. A common mistake in trading options is b
uying puts or calls when volatility is high.
ADXcellence
Power Trend Volatility 135
In the strategies presented in Chapters 10-13 and 16-17, volatility is taken int
o consideration. During periods of low ADX consolidation, volatility is low and
the risk/reward is favorable. Once a stock breaks out, volatility becomes high;
and we must minimize risk by entering on retracements.
Traders are often stopped out of positions because they do not take into account
the volatility conditions of the trade. Taking ADX strength and volatility into
consideration will give a trader more confidence in managing risk and using ADX
/DMI to confirm price signals.
ADXcellence
SECTION THREE
POWER TREND STRATEGIES
ADXcellence
138
ADXcellence
CHAPTER 8
Power Trend Principles
ADX/DMI power trend strategies are predicated on basic principles of price behav
ior. These principles represent patterns that tend to repeat over and over in al

l timeframes. In this chapter, the principles are presented as a basis for findi
ng the best and strongest trends to trade.
Understanding price behavior is probably the most important skill a trader can d
evelop. If a trader does not understand basic price and trend principles, no ind
icator is going to help them trade. Price provides a framework from which a trad
er can see the market and make trading decisions that have a higher probability
of success.
ADX/DMI is the best indicator for trading trends; it quantifies the trend streng
th, shows trend momentum, confirms trend direction, and demonstrates trend volat
ility. When ADX/DMI is applied in the context of power trend principles, the res
ult is an amazing opportunity to capitalize on the strongest trends with the gre
atest potential for gain.
ADXcellence
140 Chapter 8
I
Trade Trends when ADX is Strong
Prices alternate between periods of range expansion and contraction. Using ADX/D
MI helps the trader enter trends when range is expanding and ADX is strong. In a
ddition, ADX helps the trader stay out of low ADX, range contraction periods whe
n trend trading works poorly.
When range expands, prices will trend. When range contracts, prices will consoli
date. The best trend trading opportunities are found when ADX is strong and risi
ng (range expansion). When ADX is falling and weak (range contraction), trend tr
ading strategies are avoided.
II
Trade Trends after a Period of Low ADX
As power trend traders, we want to trade stocks with the greatest potential for
a large move. The strongest trends begin out of low ADX periods. The longer the
consolidation period, the farther the new trend is likely to travel. This concep
t is the basis for the ADXodus strategy (Chapter 10).
Large institutions accumulate or distribute stock over a long period of time. Th
e accumulation phase leads to the "markup" phase where the retail investor jumps
onboard to ride the uptrend. The distribution phase leads to the "markdown" pha
se where the retail investor exits longs (or goes short) during the downtrend. A
DX is excellent at identifying these periods of accumulation/distribution becaus
e the ADX will be low and move sideways for an extended period of time prior to
a markup/markdown phase.
Once these low ADX periods are seen, trendlines are drawn on the price highs and
lows and the trader waits to trade the breakout. Even easier, the trader can mo
nitor new price highs in the market each day or week and find setups for the sto
cks which had an extended period of consolidation prior to breaking out.
ADXcellence
Power Trend Principles 141 Figure 8.
1 RMBS Daily (Source: eSignal. www.eSignal.com)
Directional Movement^
(RMBS... RAMBU S INC DEL,D> Dynamic,fi:00,24:00
Range Expansion--Gontraction--EJcpansion
18.00
14.00
12.00
10.00
RMBS is a nice example of the range expansion and contraction principle.
From left to right, notice the downtrend and a rising ADX (range expansion). Nex
t, we see price moving sideways and the ADX falling (range contraction). The nex
t move in price is a breakout (range expansion) to a new uptrend, and ADX rises
again.
This example is a trend reversal pattern.
ADXcellence
142 Chapter 8
Figure 8.2 AETWeekly (Source: eSignal. www.eSignal.com)

From left to right, this chart of AET shows expansion as price makes new highs;
a period of range contraction as prices retrace and move sideways; and range exp
ansion with ADX rising above 25 again along with new price highs.
This example is a trend continuation pattern.
ADXcellence
Power Trend Principles 143
Figure 8.3 DECKWeekly (Source: eSignal. www.eSignal.com-)
DECK had a ten month period of low ADX. In April, 2003, the +DMI made a new high
and ADX broke above the 25 level.
In ten months, this stock made a gain of over 300%. Notice the high rounded ADX
pattern that ended in 2004, after which the ADX declined and price entered a sid
eways price pattern.
After an ADX decline and sideways price movement, stocks often make another surg
e in the direction of the previous trend. DECK rose to $45 by December, 2004, ma
king another 50% gain.
ADXcellence
144 Chapter 8
3
Look For Entries after New ADX Highs
Momentum precedes price. When ADX makes new a momentum high, new price highs/low
s are likely to follow. New ADX momentum signals a change in the balance of supp
ly and demand.
If prices make new highs along with ADX, an uptrend is likely to follow. If pric
es make new lows when ADX makes the new highs, then a downtrend is likely to fol
low.
The best strategy after new ADX highs is to let price return to an area of suppo
rt or resistance and look for an entry in the direction of the new momentum. The
re is a high probability that prices will continue to trend in the direction of
the breakout.
4
Use Trendlines to Draw Price Patterns
Many traders only want to focus on exciting stocks making news, ignoring the bor
ing stocks that appear to being doing nothing. However, the longer they bore, th
e higher they soar. As power trend traders, we don t want to miss the stocks tha
t have been doing their job of storing up energy for a big run.
Areas of support and resistance in long consolidation periods are best defined w
ith the use of trendlines. When ADX has been under 25 for a long time, put trend
lines on price and frame out the potential trade. Look for price patterns (trian
gles and rectangles). If you have trouble seeing consolidation periods, try draw
ing a line down the middle of all price bars. If the line is going sideways, you
have accumulation/distribution.
Anytime a price pattern can be drawn, the trade will have more clearly defined e
ntry points. Wait for price to beak above a resistance trendline or below a supp
ort trendline before entering the trade.
ADXcellence
Power Trend Principles 145
Figure 8.4 HITKWeekly (Source: eSignal. www.eSignal.com)
This is a low priced stock that had a six month period of sideways consolidation
. The stock then broke out (expansion) to new highs with a high ADX (>50), signi
fying new momentum in the upward direction. The stock then made a normal pullbac
k to the 20 EMA (contraction).
Stocks that suddenly register a new ADX high should catch a trader s attention (
see Figure 8.5). Look to enter breakouts on a pullback to the 20 EMA.
ADXcellence
146 Chapter 8
Figure 8.5 HITKMonthly (Source: eSignal. www.eSignal.com )
Here we see HITK on a monthly chart. After the initial breakout in 2001 (Figure
8.4), prices consolidated, and then they continued to trend in the direction of
the initial breakout. New breakouts attract attention and buying comes in to dri
ve up prices further.

Usually, the best trade is to wait for a pullback rather than chasing prices on
the breakout. This low priced stock consolidated for a year, then continued tren
ding in the direction of the initial breakout.
It climbed over 300% in the following year.
ADXcellence
Power Trend Principles 147 Figure 8.
6 BOOMMonthly (Source: eSignal. www.eSignal.com)
Here is a real boring charta monthly chart! Notice the "line" that bisects the pr
ice consolidation. You can see that about half of the price action is above the
line and half of the price action is below the line.
Trendlines drawn on the top and bottom pivots show us a triangle formation. This
is four years of boring, sideways movement. You should be thinking: if this sto
ck breaks out, it could really go (see Figure 8.7).
ADXcellence
148 Chapter 8
Figure 8.7 BOOMWeekly (Source: eSignal. www.eSignal.com)
Here is BOOM on a weekly chart showing what happened after the triangle consolid
ation period in Figure 8.6. Price broke out in late 2004 and rose over 400% in 1
2 months.
There was plenty of time to enter the trade when it pulled back to the 20 EMA in
January, 2005. Here again, price continued to trend in the direction of the ini
tial breakout and new high in ADX.
ADXcellence
Power Trend Principles 149
This weekly chart of HOLX shows an uptrend in 2003, followed by a nine month con
solidation period in 2004. The line shows sideways price movement. ADX is low in
October, 2004, after having made a peak of over 50 in April that same year.
To the eye, this chart may look overextended and ready to reverse. But direction
cannot be predicted on breakouts from consolidation. Now look at the next chart
in Figure 8.9.
ADXcellence
150 Chapter 8
Figure 8.9 HOLXWeekly (Source: eSignal. www.eSignal.com)
This chart shows what happened after the consolidation period ended in October,
2004. Price broke out again in the direction of the established trend.
The stock rose 300% by December of 2005. This is a power trend!
ADXcellence
Power Trend Principles 151
5 Trade Using Multiple Timeframes
Traders can gain an edge anytime they integrate multiple timeframes into a tradi
ng strategy. The trend on a higher timeframe should support the trade on a lower
timeframe.
Suppose we see a weekly chart with a long period of accumulation. If the daily p
rices record a new momentum high, it is likely weekly prices will follow (in a f
ew weeks). The weekly breakout has the potential for a much longer trend than th
e daily timeframe.
Traders can sometimes benefit by using a lower timeframe for an earlier entry si
gnal on breakouts because momentum on a lower timeframe precedes momentum on a h
igher timeframe. In addition, when a higher timeframe retraces to the 20 EMA, th
e lower timeframe can give earlier entry signals for the higher timeframe contin
uation.
6 Trade Only In the Direction of the Trend
Trends are more likely to continue trending than to make a reversal. Therefore,
power trend traders should always trade "with" the trend and not against it. At
any random point in an uptrend, you are more likely to trade successfully by ent
ering long than short. Likewise, at any random point in a downtrend, you are mor
e likely to trade successfully by entering short than long.
We can use this to our advantage by choosing a low risk entry in the direction o
f the trend. This is the basis of the ADXtender strategy (Chapter 13). We enter t
he trade on a retracement and look for a new leg of the trend to develop afterwa

rd. Even if the trend does not continue higher/lower, there is a high probabilit
y of our trade working out for a short swing as price retests previous highs/low
s.
ADXcellence
152 Chapter 8
Figure 8.10 HPQ Daily (Source: eSignal. www.eSignal.com )
New Momentum
2004 eSignal.
Momentum Precedes Price Price Follows Momentum
26.00
24.00
22.00
20.00
(HPQ - HEWLETT
PACKARD CO,D) Dynamic,0:00-24:00
New Momentum
This daily chart of HPQ shows two areas where prices gapped up. Gaps are a form
of new momentum. In both instances, prices followed the new momentum highs. This
chart is an excellent example of how momentum precedes price.
New momentum is due to an imbalance in supply and demand. Imbalance leads to mov
ement of prices in the new direction until a greater force changes the demand/su
pply balance. Look at the next chart on a higher timeframe (Figure 8.11).
ADXcellence
Power Trend Principles 153
Figure 8.11 HPQWeekly (Source: eSignal. wwweSignal.com,)
This is the same stock, HPQ, shown on the weekly (higher) timeframe. The weekly
chart shows a period of consolidation from October 2004 until May of 2005.
The daily breakout in Figure 8.10 preceded the weekly breakout. Both timeframes
were setting up for a move in the same direction. When the weekly momentum follo
ws the daily, there is a higher probability for an extended run in prices.
ADXcellence
154 Chapter 8
Figure 8.12 VLODaily (Source: eSignal. www.eSignal.com)
VLO made an apparent breakout in late November but quickly fell below the trendl
ine. For some, this chart may look too high to buy. The break of the trendline m
ay have caused some traders to feel like shorting the stock. But objectively, we
do not have a trend reversal on this chart.
All we know is the stock is in an uptrend and has made a new low which extended
below the rising trendline. But the bias is still up, and a trader can watch for
a low risk entry and trade for a retest of the last highs. Look at the next cha
rt, Figure 8.13.
ADXcellence
Power Trend Principles 155
Figure 8.13 VLO Daily (Source: eSignal. www.eSignal.com)
7 20 4 18 1 8 22 6 20 310 24 7 22 7 21 4 18 29 23 6 20 5 18 1 8 22 6 19 Sep Oct
Nov Dec 2005 Feb Mar Apr
May Jun Jul
Auq
Sep
This is also a daily chart of VLO, but it covers a longer period of time. The tr
endline break shown in the previous chart (Figure 8.12) is shown here by the arr
ow at the left of this chart (December, 2004).
Notice how prices continued to rise in the bigger picture. Price nearly tripled
from the point where it might have looked liked the time to sell. We cannot pred
ict how high prices will go, but they usually go much farther than we think.
ADX/DMI helps the trader to continue trading "with" a power trend. The trade is
allowed to go for as long as profits can run. There will be some trade managemen
t decisions along the way, but the bias should remain with the dominant trend.
ADXcellence
156 Chapter 8
7
Wait For Trends to Reverse Before Entering

Trends usually give a warning before making a reversal. It is not necessary (and
ill advised) to pick tops and bottoms. Follow price and wait for confirmation t
hat a trend has reversed before entering in the direction of the new trend.
Trends develop from an imbalance in supply and demand. For instance, when demand
overcomes supply, an uptrend is likely to ensue. For the uptrend to reverse dem
and must decrease or the supply must increase to tip the balance of supply and d
emand in the other direction.
This process takes time because owners of stock shares have to close positions w
hile other traders must open new positions. It is common to have a consolidation
period at tops (distribution) and bottoms (accumulation) of trends. Except duri
ng climaxes, trend reversals are usually preceded by a period of consolidation.
When supply and demand are fairly equal, we have periods of consolidation, or a
relative equilibrium. Consolidation periods persist until the supply and demand
balance changes again and we see new momentum in the same or opposite direction.
During the consolidation phase, prices often spike up and down within a range,
testing prices for new buying/selling interest.
Climax reversals are an exception. The V-Type (climax) reversal is where prices
change direction without a period of consolidation. As an example, a V-type top
develops when all the buying demand has been exhausted. There are no buyers left
to hold up price, so it declines suddenly when sellers are unopposed and supply
greatly overwhelms demand.
ADXcellence
Power Trend Principles 157
Figure 8.14 BSXWeekly (Source: eSignal. www.eSignal.com)
On the left of the chart we see an uptrend where demand is greater than supply.
At the top, we have an area where supply and demand are relatively equal and pri
ces move sideways within a range, testing the highs and lows.
On the right side of the chart is a downtrend where supply overcame demand and a
new trend developed in the opposite direction. If you were an owner of this sto
ck in early 2004, you had several months to exit your position before the trend
reversal. Trend reversals are usually a process.
ADXcellence
158 Chapter 8
Figure 8.15 HUM Daily (Source: eSignal. www.eSignal.com)
Notice the bottoming process. Supply and demand reach equilibrium, and then we s
ee a period of greater demand. There is usually plenty of time to make a good en
try after the trend reverses.
Most of the time, the best entry is when demand is clearly in control, so money
is not tied up in a consolidation period. Remember, we cannot predict the direct
ion of prices following a low volatility consolidation period.
In July, once ADX rose above 25 and prices reversed upward, an entry is made at
support near the 20 EMA.
ADXcellence
CHAPTER 9
Trading With Xcellence
Trading involves a number of different decisions about where to enter, where to
exit, and how to manage risk. In this chapter, I will present the basic trading
guidelines used when trading power trends with ADX/DMI.
The best and most profitable trades always occur in the direction of the trend,
and the stronger the trend the better. Countertrend trades are for swing traders
, not power trend traders. Attempts to trade against the trend are not only risk
ier; they also have lower profit potential.
Power trend trading is finding the best trend setups and trading in the directio
n of the dominant momentum. We may enter on a breakout of a new trend, on a pull
back in an established trend, or following a trend reversal.
The ADX/DMI strategies in this book seek to trade high ADX trends and avoid low
ADX countertrends.
ADXcellence
160 Chapter 9
TRADE WITH THE DOMINANT DMI

Successful trading has more to do with limiting big losses than making big wins.
There are two principles which will greatly improve trading results and certain
ly limit big losses. Both are based on the DMI Trade Direction Rule.
DMI Trade Direction Rule When +DMI is above -DMI, don t be shor
t. When -DMI is above +DMI, don t be long.
This rule is so simple, yet it will keep you out of more trouble than you can im
agine. Take a look at all your present losing positions and see if you are tradi
ng against the rule. Place this rule on your trading checklist before entering a
stock position. The rule is most important when ADX is greater than 25. When AD
X is less than 25, there will be frequent DMI crossovers.
If you are already in a position, the rule serves as a warning to tighten stops
as soon as the nondominant DMI makes a crossover. As long as there is no change
in dominance, the trade can be held. In high volatility conditions, the rule can
give late signals. But more often than not, you won t get hurt; you just might
not profit.
The other great benefit of this rule is to keep you out of picking bottoms and t
ops. Our egos like to pick tops and bottoms because doing it demonstrates our te
chnical analysis skills. But skill in technical analysis is not the same as skil
l in trading. Trading is finding a low risk entry with a high probability of suc
cess and booking profits regularly.
The trend will not reverse until there is a new dominant DMI. The power trend tr
ader always waits for a trend to reverse before establishing a position in the r
eversal direction. The dominant DMI signal will give you plenty of time to enter
the trade.
ADXcellence
Trading with Xcellence 161
Figure 9.1 FDODaily (Source: eSignal. www.eSignal.com)
This chart is an example of what would happen if you followed the DMI Trade Dire
ction Rule without using specific entry and exit criteria. Suppose you went shor
t both times the -DMI crossed above the +DMI and exited when the +DMI back cross
ed above the -DMI (shaded areas above).
In the first short (1), you would have made money staying on the right side of t
he -DMI signal. Exiting when the +DMI crossed above -DMI would not have affected
your profits significantly.
If you had entered short again at (2), you wouldn t have made much on the trade;
but you wouldn t have been hurt muchthat is the key. Limiting losses is how you
make money in the stock market.
ADXcellence
162 Chapter 9
Figure 9.2 ASFWeekly (Source: eSignal. www.eSignal.com)
A trade entered at (1) on the +DMI crossover (and ADX <25) would not have been a
loss if it was held for two weeks; but the gains would have been minimal. Howev
er don t be short when the +DMI is on top.
A trade entered at (2) when +DMI was dominant and ADX was above 25 shows the pow
er of ADX. The trade would have been a large gainer.
When the DMI lines are widely separated (as seen from April through December, 20
05), don t try shorting against the +DMI dominant trend.
ADXcellence
Trading with Xcellence 163
LET ADX TELL YOU WHEN TO ENTER
ADX is one of the best indicators for helping the trader manage risk. The ADX Tr
ade Entry Rule is one of the most important concepts in the book for trading pow
er trends. The rule applies to all timeframes, from one minute charts to monthly
charts. It is essential that risk be managed properly for consistent trade succ
ess. Knowing "when" to make an entry is the key to managing risk. The best stoploss is a good entry.
ADX Trade Entry Rule
When ADX is less than 25, enter on breakouts; when ADX is greate
r than 25, enter on retracements.
Low volatility means low risk and high volatility means high risk. When ADX is l

ow, the price swings are usually smaller. But when ADX is high, the price swings
can be wide. Wide swings means greater risk of being stopped out if the entry i
s not made close to support/resistance. Therefore, when the ADX is high, it is u
sually best to wait for an ADX decline and price retracement before making an en
try.
When ADX is low, there is less risk and less profit potential on the smaller pri
ce swings. But that is not the trade we want. The best entry is on a breakout ab
ove resistance or below support. Often, a resting stop can be placed just above
resistance or just below support. The entry is triggered as prices pull you into
the trade.
To summarize, when ADX and volatility are low, we should think in breakout mode
and enter on the breakout. When ADX and volatility are high, we should think in
retracement mode and enter on a retracement to support or resistance.
ADXcellence
164 Chapter 9
Figure 9.3 WSO Daily (Source: eSignal. www.eSignal.com )
WSO demonstrates high volatility with swings of ADX and DMI above 25. Buying whe
n prices are rising on an up swing is risky because of retracement risk.
Note that each time price makes a new high, it falls back to the 20 EMA, increas
ing the risk of being stopped out for a loss. This is normal behavior for a stoc
k with high volatility.
The shaded areas on ADX show how to buy in high volatility. Let ADX decline near
to 25 or below, so the initial risk is lessened. Buy at support near the 20 EMA
(usually). This is the trading concept used in the ADXtender strategy (Chapter 1
3, pg. 172).
ADXcellence
Trading with Xcellence 165 Figure 9.
4 VLOWeekly (Source: eSignal. www.eSignal.com)
Here we see low volatility while ADX is below 25 in 2003. In November, ADX begin
s rising and price breaks out above resistance.
Notice how close the breakout is to the 20 EMA support. The horizontal resistanc
e line and the trendline are close, so resistance and support are almost the sam
e. Here we have a low risk entry because prices are near support and rising up t
hrough resistance on range expansion.
A buy-stop placed above the resistance line would have made an excellent, low st
ress entry. This setup is used in the ADXodus strategy (Chapter 10) and is a clas
sic consolidation breakout strategy.
ADXcellence
166 Chapter 9
This chart shows us both types of entries on a downtrend breakout.
There is a period of low ADX consolidation from mid October to mid November. The
first entry short (1) can be made on the breakout below support. However, the e
ntry must be early (on the break of the trendline) because we are moving into hi
gher volatility and there is a higher risk of a retracement against our entry.
If we did not enter on the breakout, we must switch to retracement mode and sell
near resistance at the 20 EMA (2). Notice how the support line (once broken) no
w becomes resistance. The trendline crosses the 20 EMA near our entry, setting u
p a low risk trade.
Prices fall quickly after entry (2). This is why I like to make my entry at (1),
just in case prices take off and they don t retrace to the 20 EMA before a larg
e part of the move is over.
ADXcellence
Trading with Xcellence 167
ENTER WHEN PRICES ARE MOVING IN THE DIRECTION OF THE TREND
This might sound simple, but prices are constantly moving up and down even when
there is a dominant trend direction. When I make entries, I want price moving in
the direction of my trade. On an upside breakout, I want my long entry to trigg
er as prices are rising and breaking through resistance and making new highs.
Two types of retracement entries are diagrammed in Figures 9.6 and 9.7. During r
etracements, prices move countertrend, so the entry is made when price reverses

back in the direction of the trend. Conceptually, this principle reinforces the
power trend principle of waiting for a trend to reverse before entering. The onl
y difference is retracement entries are made on a short-term (pivot) reversal in
stead of a trend reversal.
Two types of breakout entries are diagrammed in Figures 9.8 and 9.9. On a breako
ut entry, the goal is to enter early. When power trend stocks breakout, they oft
en don t allow much time to get into the trade with today s computerized, fast-a
ction trading. Lots of buy-stops are sitting just above resistance or below supp
ort. The strong hands (institutions) jump into a trade and the stock can move fa
r and fast.
If the breakout entry is missed, then a trader must wait for a low-risk retracem
ent to execute the trade. Emotions must be held in check, for it is normal to fe
el you have "missed the trade." But the price at which a trade is entered is not
as important as the risk at which the trade is entered.
When a "missed" breakout takes off, ADX rises and volatility increases. The firs
t opportunity to enter will be with the ADXpress strategy (Chapter 12).
After that, the trader may have to wait for the ADX to decline to execute a low
risk entry near the 20 EMA, in which case the ADXtender strategy (Chapter 13) is
used.
ADXcellence
168 Chapter 9
When volatility is high in an uptrend, prices swing up and down and there is les
s bar overlap. A long trade is entered near support on a higher low pivot revers
al. The trade is first taken for a retest of the last pivot high. If price conti
nues beyond the last pivot high, then a new leg of the trend is underway. A stop
is placed under the last pivot low.
When volatility is high in a downtrend, a short trade is entered near resistance
on a lower high pivot reversal. The trade is first taken for a retest of the la
st pivot low. If the price continues beyond the last pivot low, then a new leg o
f the trend is underway. A stop is placed above the last pivot high.
ADXcellence
Trading with Xcellence
169
When volatility is low in an uptrend, prices have narrow swings up and down and
the price bars are smaller with more bar overlap. A long trade is entered on a b
reak above trendline resistance. The trade is a breakout and the first test is a
higher low above the trendline which is an alternative entry point. A stop is p
laced under the last pivot low before the breakout.
Figure 9.9
1 11 1111
Support
When volatility is low in a downtrend, a short trade is entered near on a break
below trendline support. The trade is a breakout and the first test is a lower h
igh below the trendline which is an alternative entry point. A stop is placed ab
ove the last pivot high before the breakout.
ADXcellence
170 Chapter 9
TRADE LONG IN STOCKS WITH STRONG FUNDAMENTALS
The power trend trader looks to trade quality stocks because they are more likel
y to trend and less likely to reverse. This is a general rule, but it works. I w
on t go into specifics on fundamental analysis, but I also don t want to exclude
it from the discussion.
It doesn t matter what method a trader uses to check fundamentals. The value is
in doing something to make sure the stock has a chance to trend and is not being
traded on hype, emotion, or price manipulation. The fundamental check should no
t take more than a few minutes.
USE A PROTECTIVE STOP ON ALL TRADES AT ALL TIMES
The only thing we control in trading is our risk, and we do that by using a prot
ective stop. The protective stop should be determined before the entry is made.
Location of the protective stop is more important than the entry price, because
the stop is how we gauge the risk of the trade.

There is no excuse for failing to use a protective stop. Stops are normally plac
ed under a pivot low or above a pivot high because pivots represent the most rec
ent support and resistance levels. All of the power trend strategies in this boo
k describe the location of the protective stop, so I won t duplicate that inform
ation here.
However, I do want to mention that trailing stops for uptrends can be placed two
pivots back (does not apply to entries). This gives the trade breathing room an
d protects against the deeper retracements. In downtrends, the stop is trailed a
bove the last pivot high because downtrends can reverse more quickly than uptren
ds when the shorts are squeezed out.
ADXcellence
CHAPTER 10
ADXodus
The ADXodus is a classic power trend strategy which demonstrates one of the easi
est and best uses of ADX/DMI system. The strategy finds stocks breaking out foll
owing a period of consolidation. ADXodus gets its name due to the large number of
accumulated/distributed shares ready to begin their exodus from consolidation a
nd start a new trend journey.
The ADXodus strategy is based on the principle that price undergoes periods of c
yclic volatility contraction and expansion. A stock that has been quiet for a lo
ng time will eventually become active. The main criteria for this setup are a lo
w ADX (less than 25) and a period of price consolidation lasting for about 30-60
days. The longer the consolidation, the farther price can go on a trend breakou
t.
The strategy finds stocks that have broken out above resistance or below suppor
t and enters on the first retracement. This strategy works on all timeframes, bu
t I use it primarily on daily and weekly timeframes. A monthly ADXodus can trend
for a few years. It is a good strategy for combining two timeframes and entering
on the lower timeframe breakout.
ADXcellence
172 Chapter 10
The goal is to make an early entry into a new trend and trail a stop or add to t
he position. It is an excellent wealth building strategy and can result in large
gains over time because the longer a stock consolidates the more energy it has
stored up for a new trend. The ADXodus is great strategy for the long-term invest
or looking to buy low and sell high.
When price is in a consolidation period, ADX is low and price forms patterns. Fo
r this strategy, it is useful to use trendlines to frame out the trade. The tren
dlines outline key levels of support and resistance. For a valid ADXodus trade, p
rice must cross the upper or lower trendline and DMI must make a crossover high
(Chapter 3).
ADXodus LONG SETUP
1. Price has a consolidation period for at least 30 bars (any timeframe) wit
h a price pattern.
2. ADX is less than 25 during the consolidation (preferably less than 15).
3. Both DMI lines are above ADX prior to the breakout.
4. The +DMI makes a crossover high as price breaks the
top trendline.
5. Price retraces to the 20 EMA and holds (first retracement) while the +DMI
makes a pivot low at or near 25.
6. Enter long on a price pivot low reversal (up).
7. Place a stop loss under the pivot low.
ADXodus SHORT SETUP
1. Price has a consolidation period for at least 30 bars (any timeframe) wit
h a price pattern.
2. ADX is less than 25 during the consolidation (preferably less than 15).
3. Both DMI lines are above ADX prior to the breakout.
4. The -DMI makes a crossover high as price breaks below the
bottom
trendline.
5. Price retraces to the 20 EMA and holds (first retracement) while the -DMI
makes a pivot low at or near 25.

6. Enter short on a price pivot high reversal (down).


7. Place a stop loss above the pivot high.
ADXcellence
ADXodus
173
Figure 10.1 HANS Daily (Source: eSignal. www.eSignal.com)
15 22 29 6
12
19
26
3
10
17
24 31
7
14
21 28
5
12
19
_________________Sep_______________________Oct________________________Nov_______
_________________Dec______________________
ADXodus LONG ENTRY
1. Period of sideways prices during September and October of 2005 with forma
tion of an ascending triangle.
2. ADX remains under 25 during the consolidation.
3. Both DMI lines are above ADX prior to the breakout.
4. The +DMI makes a crossover high and price breaks out.
5. Price retraces near the 20 EMA and holds, and +DMI makes a pivot low.
6. Enter long when price makes a pivot low reversal (up).
7. Place a stop loss below the price pivot low.
Note: Notice the "NO" arrow which points to a price pivot low and a new -DMI hig
h which might have been interpreted as a breakout down. The -DMI made a new high
, but price did not make a lower low; so there is no short entry signal. Both pr
ice and the momentum oscillator must agree for breakouts to be valid!
ADXcellence
174 Chapter 10
Figure 10.2 ADSKWeekly (Source: eSignal. www.eSignal.com)
1. Period of consolidation with formation of an ascending triangle.
2. ADX remains under 25 during the consolidation, reaching levels below 15.
3. Both DMI lines are above ADX prior to the breakout.
4. The +DMI makes a crossover high as price breaks above the trendline.
5. Price retraces to the 20 EMA and holds; and +DMI makes
a pivot
low.
6. Enter long when price makes a pivot low reversal (up).
7. Place a stop loss below the price pivot low.
Note: This stock went to $48.00 by late 2005.
ADXcellence
ADXodus
175
ADXodus LONG ENTRY Study Case
This is a good example to test your understanding of the ADXodus trade. This stoc
k rose over 100% in seven months. It s a true power trend trade with an ADX reac
hing over 70.
Does this stock meet the ADX criteria for an ADXodus setup?
Can you identify the consolidation pattern with trendlines?
Where was the breakout?
Where was the entry?
Where would you place your stop loss?
ADXcellence
176 Chapter 10
Figure 10.4 GCIDaily (Source: eSignal. www.eSignal.com)
ADXodus SHORT ENTRY
1. Price makes a 30 day consolidation pattern.
2. ADX is less than 25 during the consolidation.
3. Both DMI lines are above ADX prior to the breakout.
4. The -DMI makes a crossover high and price breaks below support, making a
new low.
5. Price retraces to the 20 EMA and holds while the -DMI makes a pivot low
near 25.
6. Enter short on a price pivot high reversal (down).
7. Place a stop-loss above the pivot high.
ADXcellence
ADXodus
177

Figure 10.5 KKD-Daily (Source: eSignal. www.eSignal.com)


This chart demonstrates an important lesson. During all of April, ADX was under
25 and price formed a rectangle pattern. Low ADX is a warning! Price is going to
breakout one way or the other. In the case of KKD, price broke below support an
d the -DMI made a crossover high.
If you had been long, you should have exited your position on the -DMI crossover
high. Crossover highs are a clear change of dominance. If you had no position,
and were looking to play the ADXodus strategy short, you had one day to enter bef
ore the gap down. The short entry would have been made on the price pivot high r
eversal (down) entry.
ADXcellence
178 Chapter 10
Figure 10.6 LNCRDaily (Source: eSignal. www.eSignal.com)
This chart shows a period of low ADX consolidation in late 2000. In February, 20
01, the -DMI makes a crossover high and price breaks below resistance. Price dro
pped significantly on the breakout, then retraced to the 20 EMA. The -DMI holds
at or near 25. The entry short entry is on the pivot high reversal (down).
Place a stop above the last pivot high.
ADXcellence
CHAPTER 11
ADXtra
The ADXtra is another power trend strategy looking to take advantage of stocks th
at have been accumulated or distributed by large institutional investors and are
beginning the markup/markdown phase. Rather than breaking out suddenly, the ADX
tra takes a little extra time setting up for the new trend breakout.
The ADXtra is a breakout strategy with a low risk entry at the point of the break
out rather than at a retracement to the 20 EMA. The trade sets up after a period
of consolidation when a DMI cross and hold occurs (Chapter 3). The cross and ho
ld is showing a change in DMI dominance, but without an immediate breakout.
When stocks are slowly accumulated (bottoms) or distributed (tops) by institutio
ns, price swings are kept fairly small (or within a range) to avoid attracting a
ttention from the retail investor. This is on purpose, and it is due to the slow
pace at which shares are being bought or sold. These accumulation and distribut
ion periods occur with low ADX and they form price patterns.
ADXcellence
180 Chapter 11
With a low ADX consolidation period, energy has been stored and the stock is rea
dy to make a powerful move. On the breakout, we have range expansion at the same
time price breaks resistance or support. Instead of entering on the retracement
following a breakout (as in the ADXodus), the ADXtra enters on the actual breakou
t.
The entry is made on a break through trendline support or resistance. At the sam
e time, DMI must make a new high. These trades can move quickly in the direction
of the breakout because the DMI cross and hold has already changed DMI dominanc
e and the only thing needed is for prices to breakout.
ADXtra LONG SETUP
1. Price has a consolidation period for at least 30 bars (any timeframe) wit
h a price pattern.
2. ADX is less than 25 during the consolidation (preferably less than 15).
3. Both DMI lines are above ADX prior to the breakout.
4. The +DMI makes a cross and hold as price makes a high near the top trendl
ine
5. Price makes a retracement to or slightly under the 20 EMA while the +DMI
makes a pivot low near 25.
6. Enter long when price breaks above the top trendline. The +DMI must make
a new high on the breakout.
7. Place a stop-loss under the last pivot low.
ADXtra SHORT SETUP
1. Price has a consolidation period for at least 30 bars (any timeframe) wit
h a price pattern.

2. ADX is less than 25 during the consolidation (preferably less than 15).
3. Both DMI lines are above ADX prior to the breakout.
4. The -DMI makes a cross and hold as price makes a low near the bottom tren
dline.
5. Price makes a retracement to or slightly above the 20 EMA while -DMI make
s a pivot low near 25.
6. Enter short when price breaks below the bottom trendline. The -DMI must m
ake a new high.
7. Place a stop-loss above the last pivot high.
ADXcellence
ADXtra 181
Figure 11.1 MRGEDaily (Source: eSignal. www.eSignal.com)
1. Price has a consolidation period and forms an ascending triangle.
2. The ADX was under 25 for nearly two months.
3. Both DMI lines are briefly above ADX before the breakout.
4. The +DMI makes a cross and hold and price makes a high just under the top
trendline.
5. Price makes a retracement near the 20 EMA, closing above the moving avera
ge but below the trendline.
6. Enter long on a break above the upper trendline. The +DMI makes a new hig
h.
7. A stop-loss is placed under the prior pivot low.
Note: Look closely at the +DMI peak just after (3). It was a higher peak, but si
nce it didn t get above 25, it is not a crossover high. That s why we use the DM
I Crossover High Ruleto avoid false signals. Here, the crossover high failure tur
ns into a cross and hold which leads to a valid breakout.
ADXcellence
182 Chapter 11
Figure 11.2 SWNWeekly (Source: eSignal. www.eSignal.com)
ADXtra LONG ENTRY
1. Price makes a consolidation pattern of a symmetrical triangle.
2. The ADX has been under 25 for more than 30 weeks.
3. Both DMI lines are above ADX.
4. The +DMI makes a cross and hold while price makes a new high near the up
per trendline.
5. Price closes near the 20 EMA.
6. Enter long when price breaks above the upper trendline. The +DMI makes a
new high.
7. Place a stop-loss under the last pivot low.
Note: The consolidation of about 30 weeks was plenty of time to store up energy.
This stock went up to over $40.00 by October, 2005.
ADXcellence
ADXtra
183
Figure 11.3 KYPHWeekly (Source: eSignal. www.eSignal.com)
ADXtra LONG ENTRY Study Case
Now it s your turn. Look at this chart and see if you can identify all the key s
etup features.
Notice the crossover high which I labeled "false" because price did not get abov
e the trendline resistance. This is why indicators confirm price, and price neve
r confirms an indicator.
ADXcellence
184 Chapter 11
Figure 11.4 CDaily (Source: eSignal. www.eSignal.com)
1. Price makes a consolidation of at least 30 days with a price pattern. Tr
endlines are drawn on the pattern.
2. ADX is less than 25 during the consolidation.
3. Both DMI lines are above ADX before the breakout.
4. The -DMI makes a cross and hold and price makes a low near the trendline
.
5. Price retraces near the 20 EMA while the -DMI makes a pivot low near 25.

6. Enter short when price breaks below the trendline. The -DMI makes a new
high.
7. Place a stop-loss above the pivot high near the 20 EMA.
ADXcellence
ADXtra
185
ADXtra SHORT ENTRY Study Case
Look at the daily chart of VZ and see if you can find the setup and entry.
Do you see a consolidation pattern?
Do you see a cross and hold?
Is price at or near the 20 EMA before breaking below support?
Does -DMI make a new high on the price breakout?
Where would you put your stop?
ADXcellence
186 Chapter 11
Figure 11.6 ZMHDaily (Source: eSignal. www.eSignal.com)
ADXtra SHORT ENTRY Study Case
Here is a daily chart of ZMH with a consolidation pattern known as a rising wedg
e. Price breaks below the wedge on the -DMI cross and hold. Notice that the -DMI
pivot low is above 25 on the "hold." This tells us the -DMI is strong. However,
it did not make a higher high than the preceding +DMI, so it is not a crossover
high.
Price beaks below support as the -DMI makes a new high. ADX rises above 25 and t
he downtrend is underway. As I said before, the ADXtra setups can move far and fa
st after the breakout making them an excellent trade setup using ADX/DMI. When t
hey move fast, it is often good to use the ADXpress entry which is covered in the
next chapter.
ADXcellence
CHAPTER 12
ADXpress
In today s market action, breakouts often move far before making the first retr
acement. Some power trend breakouts are like an "express" train departing from a
train stationyou either jump onboard quickly or you miss the train altogether. T
he ADXpress is an alternative entry strategy for fast moving breakouts
Generally, we trade breakouts by looking for new price highs/lows and an ADX ab
ove 25; and then we look to buy the first retracement back to the 20 EMA (ADXodu
s). But power trend stocks have stored up energy and can really fly once they bre
akout; sometimes the 20 EMA entry is too late. The ADXpress strategy is the answe
r to this problem and will ensure that you don t miss the express train.
After a breakout, price often pauses, briefly forming a tight pattern of two to
five narrow range bars near the 5 SMA or 10 SMA. The bars move more sideways th
an up or down and they may appear to form a mini flag. In the best uptrend patte
rns, price makes inside bars or slightly lower lows. In the best downtrends patt
erns, price makes inside bars or slightly higher highs.
ADXcellence
188 Chapter 12
The ADXpress takes advantage of the best signals in ADX/DMI. The DMI is used to c
onfirm the breakout with a crossover high and a rising ADX above 25 tells us the
trend strength is strong in the direction of the DMI breakout. Just think of a
trainonce it is moving, it can slow down; but it can t stop quickly. All aboard!
ADXpress LONG SETUP
1. Price makes a 20 day high
2. The +DMI makes a crossover high
3. The +DMI makes a pivot low above 25.
4. ADX is above 15 and rising.
5. Price makes a two to five bar pause near the 5 or 10 SMA.
6. Enter long on pivot low reversal (up) in price.
ADXpress SHORT SETUP
1. Price makes a 20 day low.
2. The -DMI makes a crossover high.
3. The -DMI makes a pivot low above 25.

4. ADX is above 15 and rising.


5. Price makes a two to five bar pause, near the 5 or 10 SMA.
6. Enter short on a pivot high reversal (down) in price.
ADXcellence
ADXpress
189
ADXpress LONG ENTRY
1. Price makes a 20 day high.
2. The +DMI makes a crossover high.
3. The +DMI makes a pivot low above 25.
4. ADX is above 15 and rising.
5. Price makes a 2 bar pause, forming a pivot low at the 5 SMA.
6. Entry is made on a pivot low reversal (up).
7. The stop loss is placed under the low of the pivot low.
ADXcellence
190 Chapter 12
Figure 12.2 SNDKDaily (Source: eSignal. www.eSignal.com)
1. Price makes a 20 day high.
2. The +DMI makes a crossover high.
3. The +DMI makes a pivot low above 25.
4. ADX is above 15 and rising.
5. Price makes a 2 bar pause, forming a pivot low at the 5 SMA.
6. Entry is made on a pivot low reversal (up) which was a gap up.
7. The stop-loss is placed under the 5 SMA at the level of the gap up in pr
ice (tighter stop-loss due to gap).
ADXceUence
ADXpress 191
Figure 12.3 TZOODaily (Source: eSignal. www.eSignal.com)
ADXpress SHORT ENTRY
1. Price makes a 20 day low on a wide range bar.
2. The -DMI makes a crossover high.
3. The -DMI makes a pivot low above 25.
4. ADX is above 15 and rising.
5. Price makes a retracement near the 10 SMA.
6. Entry is made on the pivot high reversal (down).
7. The stop-loss is placed above the pivot high.
ADXcellence
192 Chapter 12
Figure 12.4 CMVTWeekly (Source: eSignal. www.eSignal.com)
ADXpress SHORT ENTRY Case Study
This weekly chart of CMVT shows a classic ADXodus entry at the 20 EMA. But an ear
lier entry was possible at the 5 SMA when the -DMI made a pivot low at 25 and pr
ice touched the 5 SMA. Power trend strategies using ADX/DMI always enter on a pi
vot that defines support or resistance.
In this case, the earlier entry was not that beneficial when compared to the 20
EMA entry. But it is impossible to predict how far and fast prices will fall in
any given situation. The important thing is to understand the trade mechanics, m
anage risk, and know what triggers a valid entry signal.
ADXcellence
ADXpress
193
ADXpress LONG ENTRY Case Study
This daily chart of AMGN compares two different 20 day high breakouts.
The first 20 day high (left) is not an ADXpress trade. After making a crossover h
igh, the +DMI made a pivot low "under" 25, demonstrating a lack of express stren
gth. One clue was the several narrow range bars after the breakout which represe
nted range contraction rather than expansion.
The second 20 day high (right) is an ADXpress long setup at the 5 SMA. We see wid
e range bars on the breakout, and the +DMI made a pivot low above 25. The 5 SMA
has a steep slope. Price made a three bar pause before taking off again and gapp
ing up.
ADXcellence

194 Chapter 12
Figure 12.6 DPTRDaily (Source: eSignal. www.eSignal.com)
ADXpress LONG ENTRY Dual Timeframe Case Study
This daily chart of DPTR shows a consolidation triangle and a breakout to the up
side. The breakout has wide range bars. There is a +DMI crossover high. But wher
e is the entry? The stock has not retraced back to the 20 EMA yet, and prices ha
ve advanced over 30%.
One option is to enter on a lower timeframe. This method is presented to reinfor
ce the power trend principle of using multiple timeframes. Look at the next char
t (Figure 12.7).
ADXcellence
ADXpress
195
Figure 12.7 DPTRHourly (Source: eSignal. www.eSignal.com)
ADXpress LONG ENTRY
Dual Timeframe Case Study (Continued)
This is an hourly chart of the same breakout in Figure 12.6. We see the same fea
tures of price breaking above resistance and a +DMI crossover high. Even on the
lower timeframe, prices have not retraced to the 20 EMA.
1. The +DMI made a pivot low above 25, and price made a pivot reversal at th
e hourly 5 SMA.
2. The +DMI made another pivot low above 25, and price made a second pivot r
eversal at the hourly 5 SMA.
The lower timeframe presented two optional entry points for the DPTR breakout. E
ven when playing for the bigger moves, there is no reason a lower timeframe cann
ot be used to make an entry.
ADXcellence
196 Chapter 12
ADXcellence
CHAPTER 13
FOHE ^Wi lNNSnS
ADXtender
The ADXtender is a trend continuation strategy. Any time price makes a new high/l
ow and ADX rises above 25, we can enter on a retracement and look for strong mom
entum to "extend" the trend higher/lower.
The ADXtender follows ADX momentum to time an entry into a strong trend. The stra
tegy can be used to enter a new trend, an established trend, or as a method to a
dd to an existing position. The ADXtender is based on the price principle that st
rong trends are more likely to continue in the same direction than they are to r
everse direction. This is especially true following a strong momentum surge.
The key feature of this strategy is ADX must first rise above 25 so we know the
trend is strong. During the retracement, the DMI lines should not cross or only
cross slightly without a change in dominance. Entry is made near the 20 EMA. For
confirmation, the dominant DMI must make a continuation high (Chapter 3, pg. 43
) after entry.
ADXcellence
198 Chapter 13
After entry at the 20 EMA, we look for the trend to extend further in price. How
ever, the first target is a test of the previous high/low. If price cannot clear
the previous swing high/low, then a small profit is taken and the trade is exit
ed. A second option is take off half the position at the previous swing high/low
and allow the other half to ride.
The ADXtender is an excellent strategy for campaigning into a stock with power tr
end characteristics. Every time the stock retraces to the 20 MA (after the ADX r
ises above 25), look for an entry. Trailing stops are used to protect profits at
all times.
ADXtender LONG SETUP
1. Price makes a new high and ADX rises above 25.
2. Price retraces down near the 20 EMA.
3. ADX turns down during the price retracement.
4. The -DMI does not cross +DMI on the retracement.

5. Enter long when price makes a pivot low reversal (up) and +DMI makes a ne
w high.
6. Place a stop-loss below the price pivot low.
ADXtender SHORT SETUP
1. Price makes a new low and ADX rises above 25.
2. Price retraces up near the 20 EMA.
3. ADX turns down during the price retracement.
4. The +DMI does not cross -DMI (or crosses slightly without a change of dom
inance).
5. Enter short when price makes a pivot high reversal (down) and -DMI makes
a new high.
6. Place a stop-loss above the price pivot high.
ADXcellence
ADXtender
199
Figure 13.1 TEVADaily (Source: eSignal. www.eSignal.com)
1. Price makes a new high in early October and ADX rises above 25.
2. Price retraces to the 20 EMA.
3. ADX turns down during the price retracement.
4. The -DMI does not cross +DMI during the retracement (a sign of strength i
s a separation of 5 DMI percentage points).
5. The entry is made on the pivot low reversal (up). The +DMI makes a new hi
gh.
6. A stop-loss is placed below the pivot low at the 20 EMA.
Note: There were three additional retracements that setup potential add to entri
es. The area market "NO" refers to an area where price made new highs but ADX di
d not get above 25.
ADXcellence
200 Chapter 13
Figure 13.2 MEDIDaily (Source: eSignal. www.eSignal.com)
1. Price makes a new high and ADX rises above 25.
2. Price retraces to the 20 EMA.
3. ADX turns down during the retracement.
4. The -DMI does not cross the +DMI.
5. Enter long on a pivot low reversal (up); +DMI makes a new high.
6. Place a stop-loss below the price pivot low.
Note: Can you see any other potential entry areas near the 20 EMA?
ADXcellence
ADXtender 201
Figure 13.3 SNTODaily (Source: eSignal. www.eSignal.com)
ADXtender LONG ENTRY Study Case
Three horizontal lines show pivot reversals near the 20 EMA. Does each of them m
eet criteria for the ADXtender strategy?
The lower high in +ADX (Chapter 4, pg. 65) in late November tells us the trend s
trength is weakening. However, the +ADX peak was greater than 25, so our bias is
to continue trading with the trend. All three of the retracements to the 20 EMA
were potential entries.
ADXcellence
202 Chapter 13
Figure 13.4 NVDADaily (Source: eSignal. www.eSignal.com)
ADXtender LONG ENTRY
Here is chart with three 20 EMA pivot reversal entries.
1. This entry failed and the trade would have been stopped out. Notice that
when price made a pivot low reversal (up), the +DMI did NOT make a higher high.
If the trade gets stopped out, look to see if the DMI failed to confirm, and the
n see if there is a better entry in the next 3-5 bars.
2. This entry worked fine. Price had a wide range bar on the pivot reversal
and the +DMI made a new high.
3. The last entry met our criteria for entry. A +DMI bearish divergence form
ed after the entry and prices reversed back through the previous swing high. Do
not take this trade when there is momentum divergence.

ADXcellence
ADXtender
203
Figure 13.5 SFCCDaily (Source: eSignal. www.eSignal.com)
1. Price makes a new low under horizontal trendline support and ADX rises ab
ove 25.
2. Price retraces up to the 20 EMA.
3. ADX turns down slightly during the price retracement.
4. The +DMI does not cross -DMI on the retracement.
5. A short entry is made on the pivot high reversal (down); the -DMI makes a
new high.
6. A stop-loss is placed above the price pivot high near the 20 EMA.
ADXcellence
204 Chapter 13
Figure 13.6 MLS Daily (Source: eSignal. www.eSignal.com)
1. Price breaks below horizontal support and ADX rises above 25.
2. Price retraces back up to near the 20 EMA.
3. ADX turns down slightly during the retracement.
4. The +DMI does not cross -DMI during the price retracement, and there is g
ood separation.
5. A short entry is made on a pivot high reversal (down).
6. A stop-loss is placed above the price pivot high near the 20 EMA.
ADXcellence
ADXtender
205
Figure 13.7 MGLN Daily (Source: eSignal. www.eSignal.com)
ADXtender SHORT ENTRY Study Case
In late September we see about 30 days of consolidation. The -DMI makes a cross
and hold followed by a breakout below support. What type of setup was this?
This was an ADXtra short entry that retraced back above the support trendline (un
usual) to the 20 EMA. However, the position would not have been stopped out. The
20 EMA provided resistance.
The ADX rose above 25 on the next down swing, rising to 50 before making a sligh
t dip. Price retraced to the 20 EMA in October. At that point, there was an ADXt
ender short entry which led to further downward prices.
ADXcellence
206 Chapter 13
Figure 13.8 IVGNDaily (Source: eSignal. www.eSignal.com)
ADXtender SHORT ENTRY Study Case
There is often a tendency to short "apparent" tops in a trend; but this is risky
and totally unnecessary. The most important thing is to find a low risk entry w
ith a high probability of success.
Where would you make your entry in this stock? Where would you put your stop-los
s?
ADXcellence
ADXtender
207
Figure 13.9 BABYWeekly (Source: eSignal. www.eSignal.com)
ADXtender LONG ENTRY Study Case
How many setups do you see in this chart for long entries? Is this a stock that
might have provided some add to entries?
ADXcellence
208 Chapter 13
Figure 13.10 AGIXDaily (Source: eSignal. www.eSignal.com)
ADXtender LONG FAILURE
Here we see prices breakout to new highs and ADX rises above 25. But on the retr
acement, price penetrates the 20 EMA. The +DMI declines and the -DMI makes a cro
ss and hold, taking away dominance from the +DMI.
No long entry could be taken on the price and DMI signals; therefore, no loss wa
s incurred. Using the ADXtender setup criteria will help keep you out of bad trad
es.
ADXcellence
SECTION FOUR

THE POWER OF TIME


ADXcellence
210
ADXcellence
CHAPTER 14
Xpanding TIME
Without an understanding of price relationships in multiple timeframes, a trader
will have difficulty becoming consistently profitable. Timeframes represent one
of the most important edges in trading. In this chapter, I discuss the importan
t elements of time and demonstrate how to integrate dual timeframes into a tradi
ng plan.
A trend trader who understands the relationships between multiple timeframes has
a distinct advantage over traders who stay fixed in a single timeframe. One of
the most common mistakes made by novice traders is failing to look at a higher t
imeframe before pulling the trigger on a trade.
With a basic understanding of timeframes, a trader will greatly improve their gr
asp of technical analysis and make better trading decisions.
Market vision is the ability to see price structure within the context of time.
It takes experience to "see the market," to understand price action, see support
and resistance, and recognize trend. It takes even more experience to see the m
arket in multiple timeframes. I say this because gaining market vision is a proc
ess, a skill that is learned through repetition. Don t expect to see it all at o
nce.
ADXcellence
212 Chapter 14
PRINCIPLES OF MULTIPLE TIMEFRAMES
Understanding the basic principle of multiple timeframes is important for power
trend trading. The more these principles can be applied to a trading plan, the b
etter the potential outcome.
1. Every timeframe has its own characteristics of trend strength, direction,
momentum, and volatility.
2. The higher timeframe governs the lower timeframe.
3. Trends on different timeframes can move in different directions for the sa
me stock.
4. Momentum on a lower timeframe precedes momentum on a higher timeframe.
5. The best trends occur when two or more timeframes are trending in the same
direction.
6. The longer-term the moving average, the less often price retraces to it.
The Higher Timeframe Governs the Lower Timeframe
Our ADX/DMI trade setups will occur on "some" timeframe, but there is usually a
higher timeframe to give us the bigger price picture. In addition, there is usua
lly a lower timeframe to give a more magnified look at the picture detail. We ca
n think of these timeframes like photographic lenseswe can look at a higher timef
rame to get a wide angle view, or we might use a lower timeframe to get a teleph
oto view.
Trend traders should always use two timeframes. The most important timeframe is
the higher timeframe, for it governs the lower timeframe. The higher timeframe h
elps us understand the bigger forces moving price and it lets us know if we are
bucking the larger trend. We have the "wind at our back" if we enter in the dire
ction of both the higher and lower timeframes. Using a lower timeframe allows be
tter risk management.
ADXcellence
Xpanding Time 213
Figure 14.1 PD Daily (Source: eSignal. www.eSignal.com)
Here we have a daily trend reversal. If we only looked at this chart, we might b
e thinking of shorting the downtrend; and that might be a good trade for a swing
trader. Price is under the 50 day EMA (bearish) and price is making new lows.
Before we decide, we ll take a wide angle look at the weekly chart, our higher t
imeframe (see Figure 14.2).
ADXcellence

214 Chapter 14
Figure 14.2 PDWeekly (Source: eSignal. www.eSignal.com)
(PD : PHELPS DODGE CORPJVJ Dy n a m jc,0:00:24:00
Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May
2002____________________________________2003
2004
WEEKLY
50 EMA
50.00
40.00
30.00
Copyright 2004- eSignal.
50
27.27
Directional Movement(13,8J
The weekly chart of PD gives us the bigger picture. Now we see that PD had a per
iod of consolidation (triangle pattern) that broke out into a new trend with hig
h ADX in 2003.
Prices entered a retracement in May, 2004, dropping to the 50 "weekly" EMA. The
downtrend on the daily chart (Figure 14.1) was merely a pullback on the weekly c
hart!
Since the weekly ADX made new momentum highs above 50, we should be biased towar
d a bounce off the 50 weekly EMA and a retest of the price highs. Now look at th
e next chart, Figure 14.3.
ADXcellence
Xpanding Time 215
Figure 14.3 PDDaily (Source: eSignal. www.eSignal.com)
Indeed, notice how price exploded out of the May lows due to the wind at our bac
k concept. The higher timeframe (bigger picture) told us to look for a potential
weekly reversal at the weekly 50 EMA. On the daily we had confirmation of a tre
nd reversal and a long entry is made.
Trends that reverse quickly (V-type) are often due to a higher timeframe retrace
ment. In the next chapter, the ADXplosive strategy will be introduced to trade th
is type of pattern.
ADXcellence
216 Chapter 14
Figure 14.4 DCAIDaily (Source: eSignal. www.eSignal.com)
DCAI is in an uptrend on the daily chart. The +DMI made a crossover high in May
and took over dominance. But the ADX is under 25 from mid May through July, indi
cating a weak uptrend. Is this a good stock for entering long?
The stock does not meet our criteria for a power trend trade. Now let s look at
the next chart and see why (see Figure 14.5).
ADXcellence
Xpanding Time 217 Figure 14.5
DCAIWeekly (Source: eSignal. www.eSignal.com)
{DCAI - DIALYSIS CQBP AMER,W) Dynaml
Higher (Weekly)! Timeframe
Copyright 0 2004 eSignal.
4:00
Hi
35.00
30.00
Lower High in Price Lower High in +ADX
Directional
............... ...... /
Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr MayJun Jul Aug Sep Oct Nov Dec _______
_____________________MS__________________________________________^_______
When in doubt, zoom on out! This weekly chart of DCAI shows what is really happe
ning. The gray shaded area represents the daily trend from Figure 14.4. Price ma
de a lower weekly pivot high and the ADX is lower too.

It is clear the uptrend on the daily chart was going nowhere and it would not ha
ve been a good long trade from a risk/reward standpoint. Instead, it would have
been a short setup since price continued the weekly downtrend after making a piv
ot high reversal.
ADXcellence
218 Chapter 14
Figure 14.6 ADBEWeekly (Source: eSignal. www.eSignal.com)
ADBE is in a weekly uptrend and prices have retraced to the trendline support ar
ea. Might this be an opportunity to enter long, either as an add to position or
a new position?
The -ADX during the retracement (to this point) is lower than the +ADX peak of t
he last highs. A trader might consider entering long if the daily chart breaks o
ut to a new uptrend (See Figure 14.7).
ADXcellence
Xpanding Time 219
Figure 14.7 ADBEDaily (Source: eSignal. www.eSignal.com)
After zooming in and waiting for a trend reversal on the daily timeframe (lower
timeframe), a long entry could be made with the higher timeframe supporting the
decision. The gain was 30% in about two months. Once a trade is entered on a low
er timeframe, risk is managed on the lower timeframe until the higher timeframe
completes a reversal.
ADXcellence
220 Chapter 14
Momentum on a Lower Timeframe Precedes Momentum on a Higher Timef
rame
Momentum precedes price, and momentum on a lower timeframe precedes momentum on
a higher timeframe. The lower timeframe gives earlier breakout and reversal sign
als than the higher timeframe (assuming the higher timeframe follows through). C
onsequently, the lower timeframe can be a leading indicator for the higher timef
rame.
One of be best applications of multiple timeframes can be seen with ADX/DMI. By
using dual timeframes, we can improve the probability that our entries will resu
lt in a profitable trade. This is especially helpful during low ADX periods wher
e price and indicator signals are often equivocal or false.
Risk management is one of the benefits of using a lower timeframe for entry. Pla
cing a stop-loss under a 20 EMA on an hourly chart will be tighter than placing
a stop-loss under the 20 EMA on a daily chart. Using a lower timeframe also magn
ifies the price action to better demarcate support and resistance trendlines.
In the following examples, I will show how to think in multiple timeframes. It i
s important to gain a feel for the interrelationships of price and time. The spe
cific trades are not as important. I merely want to show the thought process.
ADXcellence
Xpanding Time
221
Figure 14.8 BNTDaily (Source: eSignal. www.eSignal.com)
On this daily chart, there is a long period of low ADX. Right away, one should b
e thinking in breakout mode. But which way will price breakout?
Consolidation patterns can breakout in either direction. New highs would be made
above the upper trendline at $12.00. Now, let s check the higher timeframe (See
Figure 14.9).
ADXcellence
222 Chapter 14
Figure 14.9 BNTWeekly (Source: eSignal. www.eSignal.com)
This is my wide angle lensthe weekly chart. Here I see a downtrend channel with a
n apparent climax low. Price then broke above the upper channel trendline. I not
ice the large consolidation triangle on the daily chart is represented on this w
eekly chart as a small flag formation (bullish).
The ADX is low, so the weekly is also in breakout mode. Price has put in both hi
gher highs and higher lows, so I have evidence of a trend reversal in the up dir
ection. All of this information leads me to believe the daily chart may break ou
t into an uptrend; so that will be my bias. Now, for an entry, I will drop down

to an hourly chart (see Figure 14.10).


ADXcellence
Xpanding Time 223
Figure 14.10 BNTHourly (Source: eSignal. www.eSignal.com)
Now I have drilled down to the hourly chart. On this timeframe, I see an ascendi
ng triangle pattern (bullish). The top of the trendline is near my $12.00 resist
ance on the daily chart. All systems go, so far.
On November 3, 2005, price gaps up on the hourly chart, making a new high above
resistance. The +DMI makes a crossover high indicating the dominant direction is
now UP. Price then retraces briefly to the 10 SMA. A long entry is made on the
pivot low reversal (up) using the ADXpress strategy.
Only intraday traders need to concern themselves with the hourly chart. But the
principles are the same whether using monthly, weekly, or daily charts. Now look
at Figure 14.11, our next chart.
ADXcellence
224 Chapter 14
Figure 14.11 BNDDaily (Source: eSignal. www.eSignal.com)
A later chart of the daily shows our ADXpress trade using multiple timeframe anal
ysis. We entered above the top trendline after an hourly breakout and retracemen
t to support.
The hourly breakout allowed me to see the entry with my telephoto lens and use t
ighter risk management. A nice uptrend followed and ADX rose above 25 on the dai
ly chart, reaching over 50 at this point.
Note: I discussed the decision points for this trade in some detail, but the ana
lysis should take less than a minute. Most advanced traders are already familiar
with this process, but I presented it here as an example of how to think in mul
tiple timeframes for those who have less experience with multiple timeframe anal
ysis.
ADXcellence
CHAPTER 15
Time Lines
Managing timeframes is challenging and requires the trader to think in more than
one dimension at the same time. Moving averages help us see time because they r
epresent different timeframes when applied to the same chart.
Moving averages are important for power trend trading. They allow us to see mult
iple timeframes at once, and they show key support and resistance levels. In thi
s chapter, I review moving averages and how they can be used to improve the trad
er s perspective.
Moving Averages and Timeframes
Moving averages are "trendlines that curve." They are used to see trend directio
n and speed and as areas of support and resistance. I think of the moving averag
es as "zones" rather than hard price targets. When price is nearing a moving ave
rage, it is getting closer to resistance or support; but I take my signals from
price, not the moving average. The moving average itself is not as important as
what price does when it gets there.
ADXcellence
226 Chapter 15
When trends are very strong, price remains above the 20 EMA for that timeframe.
The 20 EMA is the short-term moving average. The 50 EMA represents the intermedi
ate-term moving average, and the 200 EMA represents the long-term moving average
. Prices returns to every one of its moving averages at some point. The longer-t
erm the moving average, the less often price retraces to it (Rule 6, Principles
of Multiple Timeframes).
In strong trends, trades are usually entered on retracements to the 20 EMA; but
the entry is only made after price makes a pivot reversal. This rule keeps trade
rs from simply buying/selling at the 20 EMA and failing to watch price. If price
blows through the 20 EMA, it will often retrace to a longer-term moving average
.
One way to watch multiple timeframes at once is to place multiple moving average
s on one chart, with each moving average representing a different timeframe. For

instance, if you trade off a daily chart, the 20 EMA will be your main entry zo
ne for retracements. But if you place a 100 EMA on your daily chart, you will be
looking at the 20 EMA of a weekly chart (5 days per week, so 5 x 20 = 100).
If you enter a position when price is near both the 20 EMA and 100 EMA on a dail
y chart, you will have your daily and weekly timeframes aligned (see Rule 5, Pri
nciples of Multiple Timeframes). Using two moving averages this way helps the tr
ader see price in relation to the 20 EMA on two timeframes at once.
Other moving average combinations are possible, but when prices are above the 20
EMA, we know we are trading the strongest trends; and strong trends are the bes
t with respect to risk and reward. Using two moving averages on the same chart a
lso helps the trader assess potential retracement risk, something I will discuss
in the next section.
ADXcellence
Time Lines 227
Figure 15.1 WLPDaily (Source: eSignal. www.eSignal.com)
By having the 20 daily EMA and the 100 daily EMA (weekly 20 EMA) on the same cha
rt, we can see both timeframes at the same time. This keeps us from having to ch
ange timeframes on our chart because we are seeing the daily support (20EMA) and
weekly support (100EMA) at the same time.
When a trader uses the 20, 50, and 200 day EMA lines on the same chart, the shor
t, intermediate, and long-term timeframes are all represented. When all three li
nes are rising, all three timeframes are in uptrends.
ADXcellence
228 Chapter 15
Figure 15.2 WLPWeekly
This chart shows WLP with price testing the 20 weekly EMA. The pivots shown at t
he three arrows correspond to tests of the 100 EMA on the previous daily chart (
Figure 15.1).
When we trade with the wind at our back, we are long when price is above the dai
ly 20 EMA and the weekly 20 EMA (100 EMA on daily). This is a simple double-chec
k before making an entry.
ADXcellence
Time Lines 229
Figure 15.3 MCODaily (Source: eSignal. www.eSignal.com)
We know the 20 EMA represents the short-term moving average. When price is above
a rising 20 EMA, the trend is usually strong. The shaded area shows an example
of price crossing the 100 EMA and 20 EMA on a daily chart. This tells us the wee
kly short-term trend is "in gear" with the daily short-term trend and both are s
trong.
In addition, the moving averages separate after the 20 EMA crosses above the 100
EMA. This is confirmation the trend is increasing in strength. Rising trend str
ength is confirmed by the ADX peak in June which registered above 30.
ADXcellence
230 Chapter 15
RETRACEMENT RISK
One of the principles of moving averages is prices always return to them at some
point (Rule 6, Principles of Multiple Timeframes). The shorter the moving avera
ge timeframe, the more often price will return it. The longer the moving average
timeframe, the less often price will return to it. When price has not returned
to a longer-term moving average in a while, we have to be concerned with retrace
ment risk.
Retracement risk occurs when price is "far off" its moving average (any moving a
verage). This works in our favor when buying pullbacks at the 20 EMA in an uptre
nd because the retracement risk is low when price is near the 20 EMA; but there
might be retracement risk on a higher timeframe.
For instance, if we buy at the daily 20 EMA, but price is high off the weekly 20
EMA, there is still significant retracement risk. Price may drop through the da
ily 20 EMA and test the daily 100 EMA (weekly 20 EMA).
One of the trend principles is that retracements tend to alternate between simpl
e and complex (ABC type). A simple retracement in an uptrend will usually stop a

t the 20 EMA. A complex retracement will often reach the 50 EMA or 100 EMA. An i
mportant clue to trading dual timeframes is knowing a simple retracement on a hi
gher timeframe is often represented by a complex retracement on the lower timefr
ame.
Many bad entries fail to take into consideration the higher timeframe concept. B
y looking at a higher timeframe, we can avoid the pitfalls of unexpected retrace
ments that either stop us out of our position or give us a big loss.
Higher timeframe analysis often answers questions about why a certain trade didn
t work like we had expected. Fortunately, we can also gain an edge by knowing h
igher timeframe concepts; and we take advantage of this with the ADXplosive strat
egy described in Chapter 17.
ADXcellence
Time Lines 231
Figure 15.4 RIGDaily (Source: eSignal. www.eSignal.com)
RIG is an example of a daily uptrend. Price is above the 20 EMA in January and F
ebruary, 2005, and there is an ADX peak of over 50 at the end of February.
Price consolidates in March and then breaks out again in early April. This may l
ook like a power trend breakout, but it is not (See Figure 15.5).
ADXcellence
232 Chapter 15
Figure 15.5 RIG Daily (Source: eSignal. www.eSignal.com)
This shows the April breakout in Figure 15.4. The breakout was a head fake to dr
aw in buyers before prices reversed down. Why did this happen?
First, let s look for ADX/DMI clues. The +ADX peak on the April breakout made a
lower high when compared to the +ADX peak before the consolidation. This tells u
s the breakout strength was weaker than the trend strength before the consolidat
ion.
But there is another reason (see Figure 15.6).
ADXcellence
Time Lines 233
Figure 15.6 RIGWeekly (Source: eSignal. www.eSignal.com)
This is a weekly chart of RIG. It shows the April breakout on the daily was high
off the weekly 20 EMA. There was significant retracement risk to a long entry o
n the daily breakout.
Also, notice the lower +DMI high in April, 2005, which was divergent with price
on the breakout (bearish divergence). Following divergence, we can expect a rete
st of the recent lows or 20 EMA support.
One cannot tell exactly when prices will retrace on the higher timeframe, but it
is important to be aware of possible retracement risk before entering a trade,
so the risk can be avoided or managed accordingly.
ADXcellence
234 Chapter 15
ADXcellence
CHAPTER 16
ADXplosive
ADXplosive is a dual timeframe strategy based on a higher timeframe retracement.
With this strategy, ADX momentum waves are compared in two timeframes. When this
trade sets up, the results are often explosive.
The power of ADX is not fully known until the integration of dual timeframes. Th
e concept of power trends beginning out of low ADX periods has already been cove
red extensively. The ADXplosive strategy is based on low ADX periods in two timef
rames. With explosive power stored up in two timeframes, the trends have the pot
ential to run faster and farther.
The ADXplosive strategy can be used on all timeframes. For power trend investors,
the weekly (higher timeframe) and daily (lower timeframe) work well. Momentum t
raders may use the daily and hourly; and day traders will use two intraday combi
nations.
I use this strategy when trading S&P futures and when making directional trades
with options. During periods of low ADX, options premium is relatively low and m
ore attractive from the buy side.

ADXcellence
236 Chapter 16
Figure 16.1 TALXWeekly and Daily (Source: eSignal. www.eSignal.com)
In Figure 16.1 above, we see side by side charts of TALX. The weekly is on the l
eft and the daily is on the right. I have drawn arrows showing how weekly prices
correlate to daily prices. One weekly bar will be represented by 5 daily bars o
n the right.
ADX is low on both charts with readings of 16 on the weekly and 10 on the daily.
This is a ripe setup for a dual timeframe, ADXplosive breakout. Notice on both o
f these charts price is going sideways. You can tell this by the horizontal orie
ntation of the 20 EMA. Also, if you drew a line through the middle of the price
bars, you would have a fairly horizontal line on both charts.
To find these setups, scan for low ADX on weekly and daily charts. Conceptually,
remember that a period of low ADX consolidation on a daily chart will usually l
ook like a single ADX trough on a weekly chart. The governing timeframe is the w
eekly (higher timeframe), so the weekly must look setup or you should move on to
another chart.
ADXcellence
ADXplosive 237
When the two conditions for low ADX are met, the entry is made after a breakout
on the lower timeframe (daily) chart. Entry is made on a pullback to the 20 EMA
on the daily. The weekly breakout signal will lag compared to the daily. By the
time price has retraced to the daily 20 EMA, the weekly DMI must have crossed in
the direction of the trend breakout (a +DMI crossover for uptrends and a -DMI c
rossover for downtrends).
Frequently, daily price will cross more than one moving average on the breakout,
and the best trades occur when price crosses the 20, 50, and 200 moving average
s at the same time on the lower timeframe. Trail a stop once the new trend is es
tablished. Don t underestimate how far these power trends can travel.
ADXplosive LONG SETUP (Weekly and Daily Timeframes)
1. Weekly chart has an ADX of less than 25.
2. Daily ADX is less than 25 and price has a period of low ADX consolidation
of at least 20 bars
3. Price breaks out above daily resistance and ADX rises above 25 on the dai
ly chart.
4. Price retraces down to the 20 EMA on the daily chart.
5. The +DMI crosses (or is above) the -DMI on the weekly by the time price r
etraces to the daily 20 EMA.
6. Enter long on a pivot low reversal (up) on daily chart.
7. Place a stop-loss under the pivot low near the daily 20 EMA.
ADXplosive SHORT SETUP (Weekly and Daily Timeframes)
1. Weekly chart has an ADX of less than 25.
2. Daily ADX is below 25 and price has a period of low ADX consolidation of
at least 20 bars.
3. Price breaks out below daily support and ADX rises above 25 on the daily
chart.
4. Price retraces up to the 20 EMA on the daily chart.
5. The -DMI crosses (or is above) the +DMI on the weekly by the time price r
etraces to the daily 20 EMA.
6. Enter short on a pivot high reversal (down) on the daily chart.
7. Place a stop-loss above the pivot high near the daily 20 EMA.
ADXcellence
238 Chapter 16
Figure 16.2 TALXWeekly (Source: eSignal. www.eSignal.com)
(TALX - TALX CORP.W) Dynamic,0:00-24:00
Jan Feb Mar Apr MayJun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May
2004
2005
ADXplosive LONG SETUP (Weekly)
See the description under the daily chart that follows (Figure 16.3).
ADXcellence

ADXplosive 239
Figure 16.3 TALXDaily (Source: eSignal. www.eSignal.com)
1. Weekly chart (see Figure 16.2) shows an ADX of less than 25. Notice the t
riangle price pattern.
2. Daily chart has a period of consolidation of at least 20 bars. ADX is bel
ow 25.
3. Price breaks above the daily resistance trendline and ADX rises above 25.
4. Price retraces down to the daily 20 EMA.
5. The +DMI is above the -DMI on weekly chart when price retraces to the 20
EMA daily (see Figure 16.2).
6. Enter long on a pivot low reversal (up) at the daily 20 EMA.
7. Place a stop-loss under the pivot low reversal. Trail your stop up and co
nsider adding to your position on subsequent price pullbacks.
Note: TALX rose over 180% in 15 months!
ADXcellence
240 Chapter 16
Figure 16.4 MYOGWeekly (Source: eSignal. www.eSignal.com)
MYOG made a nine month consolidation pattern, recording a very low weekly ADX in
the first six months of 2005. The -DMI made a new high at the end of June, but
prices did not make a lower low (stayed above the lower trendline), so there was
n t a valid crossover high.
In July, the +DMI made a valid crossover high as prices broke through the resist
ance trendline (See Figure 16.5).
ADXcellence
ADXplosive
241
Figure 16.5 MYOGDaily (Source: eSignal. www.eSignal.com)
On the daily chart of MYOG we see a low ADX period from May to July, 2005. The +
DMI made a valid crossover high in mid July, and prices broke above the daily re
sistance trendline, taking out the May highs.
The first entry was before the first gap, when prices paused and moved sideways
for a week. This is where the ADXpress entry can be employed for an earlier entry
on a fast mover. The stock gapped up a second time in August, showing the explo
sive nature of these dual timeframe patterns.
ADXcellence
242 Chapter 16
Figure 16.6 ISRGWeekly (Source: eSignal. www.eSignal.com)
ADXplosive LONG ENTRY (Weekly)
ISRG has a consolidation pattern on this weekly chart and a low ADX. Now look at
the next chart, Figure 16.7.
ADXcellence
ADXplosive 243
Figure 16.7 ISRGDaily (Source: eSignal. www.eSignal.com)
Price formed a consolidation triangle on the daily chart in May. Prices broke ab
ove the triangle and the +DMI made a crossover high. Prices retraced to just bel
ow the 20 EMA, providing an entry long on the +DMI pivot low.
ADXcellence
244 Chapter 16
Figure 16.8 NYTWeekly (Source: eSignal. www.eSignal.com)
Jul Aug Oct Nov Jan Feb Apr JunJul Aug Oct Dec Jan Ma|\
2004
_______________________
_2005
50.00
48.00
46.00
44.00
42.00
JA t\t\
39.6095
Copyright O 2004 eSignal.
Directional

ovemeret{13,8|
11.07
0
(NYT - NEW YORK TIMES CQ,W) Dynamic,0:00-24:00
35.26
25
ADXplosive SHORT ENTRY (Weekly)
See the next chart (Figure 16.9) for the explanation.
ADXcellence
ADXplosive
245
Figure 16.9 NYTDaily (Source: eSignal. www.eSignal.com )
1. The weekly chart has an ADX of less than 25 in early 2004 (Figure
16.8).
2. Daily ADX is less than 25 and in a consolidation pattern.
3. Price breaks out below support and ADX rises above 25.
4. Price retraces toward the 20 EMA and pauses.
5. The -DMI crosses above the +DMI on weekly (see Figure 16.8).
6. Entry is made on the pivot high reversal.
7. Place a stop-loss above the pivot high near the 20 EMA.
Note: These patterns are explosive and often do not fully retrace to the 20 EMA.
The ADXpress entry can be used near the 5 or 10 SMA.
ADXcellence
246 Chapter 16
Figure 16.10 IFFWeekly (Source: eSignal. www.eSignal.com)
ADXplosive SHORT ENTRY (Weekly)
Study Case
Study this chart for a higher timeframe (weekly) setup, and then look at Figure
16.11.
ADXcellence
ADXplosive
247
Figure 16.11 IFFDaily (Source: eSignal. www.eSignal.com)
ADXplosive SHORT ENTRY (Daily)
Study Case
This daily chart shows a daily breakout and a retracement slightly above the 20
EMA. Where would you have made an entry? Where would you have put your stop-loss
?
An early entry could have been made short on the pivot high reversal on the 28th
of March. That position would have been stopped out when price crossed above th
e 20 EMA in April. But there are two other entry opportunities near the 20 EMA.
How would you trade them?
ADXcellence
248 Chapter 16
ADXcellence
CHAPTER 17
ADXquisite
The ADXquisite is another dual timeframe strategy. This strategy is exquisite becau
se of the combination of psychology and technical analysis. It is one of the few
times that we can feel like we weren t outsmarted by the market makers and spec
ialists.
The ADXquisite is the most complicated of all the strategies in this book, so I s
aved it for last. I especially like this strategy because so many traders can t
see it or don t look for it. Psychologically, traders with weak hands are challe
nged as well as traders who like to enter trend reversals early. But neither see
s what is really happening with price and trend because they are only looking at
one timeframe.
The higher timeframe is used as our filter and is the basis for our entry on the
lower timeframe. I like to use combinations of weekly/daily, daily/60 minute, a
nd 60 min/15 minute charts. For power trend traders, the weekly and daily charts
will give the best run. This strategy works on all timeframes (dual) and can le
ad to excellent power trend conditions.

ADXcellence
250 Chapter 17
WEEKLY SETUP
For this strategy, the weekly chart must have made a recent ADX high of at least
25 on higher highs (uptrend) or lower lows (downtrend) in price. This means the
weekly (long-term) timeframe is in trend mode. For this part of the strategy, i
t is much like the ADXtender setup.
On a weekly retracement, price may go slightly farther than the weekly 20 EMA, b
ut it should be in the zone. We then look for price to make a weekly pivot rever
sal. We monitor the reversal on a daily chart (lower timeframe) for an earlier s
ignal. The weekly ADX will decline when price retraces near the 20 EMA (ADX Retr
acement Rule, Chapter 4, page 55).
DAILY SETUP
On the daily chart (lower timeframe), we look for what "appears" like a trend re
versal; but it isn t! It will actually be an ABC pullback. During an uptrend, th
e ABC pullback will cause weak hands to bail out, and some early shorts will als
o enter. This adds a lot of energy to the setup, and price can take off fast in
the direction of the last weekly high.
ABC pullbacks are complex corrections (described by Elliott) where the C wave ex
tends beyond the low of the A wave. When the C wave makes a lower low, many trad
ers go short and the weak hands may exit their long positions.
Figure 17.1 shows two types of retracements. The first is a simple retracement r
epresented by "one swing" back to support. The second is a complex retracement w
ith "three swings" back to support. The deceptive nature of the complex retracem
ent is shown by the B wave which makes a lower high and the C wave makes a lower
low.
ADXcellence
ADXquisite
251
In uptrends, a lower high and lower low often begin a reversal to the downside.
However, the power trend criteria for a reversal to a downtrend are not truly me
t (Figure 5.16, pg. 95).
It is only by looking at the higher timeframe that we see what is actually happe
ning with price and trend. Remember, the higher timeframe governs the lower time
frame (Rule 2, Principles of Multiple Timeframes).
A key to the ADXquisite is the daily ADX pattern during retracement. Using the co
ncept of ADX relative strength (Chapter 4, pg. 73), we study the two timeframes
to give us our bias for the trade.
The patterns are diagrammed in Figures 17.2 (uptrend with ABC) and 17.3 (downtre
nd with XYZ).
ADXcellence
252 Chapter 17
In an uptrend, the highest +ADX peak that precedes the ABC retracement will be h
igher than the -DMI peak formed at the end of the C wave. This is an example of
ADX relative divergence and the Countertrend ADX Relative Strength Rule (Chapter
4, page 73).
In a downtrend, the highest -DMI peak that precedes the XYZ retracement will be
higher than the +DMI peak formed at the end of the Z wave. Downtrend retracement
s are labeled XYZ to distinguish them from uptrend retracements.
ADXcellence
ADXquisite
253
ADXquisite LONG ENTRY (Weekly and Daily Timeframes)
1. The weekly ADX has made a +ADX peak of 25 or greater.
2. Price makes a retracement down to the weekly 20 EMA.
3. The weekly -DMI does not cross the weekly +DMI on the retracement to the
20 EMA.
4. The daily price bars make an ABC retracement (about 20-40 bars).
5. The daily +DMI makes a crossover high (or cross and hold) while price mak
es a new high above resistance.
6. Enter long when price retraces to the 20 day EMA using the pivot low reve
rsal method.

7. Place a stop-loss under the pivot low at the 20 EMA.


ADXquisite SHORT ENTRY (Weekly and Daily Timeframes)
1. The weekly ADX has made a -ADX peak of 25 or greater.
2. Price makes a retracement up to the weekly 20 EMA.
3. The weekly +DMI does not cross the weekly -DMI on the retracement to the
20 EMA, or crosses it slightly (see note below).
4. The daily price bars make an XYZ retracement (about 20-40 bars).
5. The daily -DMI makes a crossover high (or cross and hold) while price mak
es a new low below support.
6. Enter short when price retraces to the 20 day EMA using the pivot high re
versal method.
7. Place a stop-loss above the pivot high at the 20 EMA.
Note: In downtrends, the price swings tend be more violent and they will gap dow
n frequently. When price retraces back up to the 20 EMA, there is more upward fo
rce because of shorts covering. It is alright if the +DMI crosses slightly above
the -DMI on the weekly timeframe, but it cannot change DMI dominance. In cases
where there is a slight cross of the +DMI over the -DMI, be sure the -DMI is on
top again before making a daily entry.
ADXcellence
254 Chapter 17
Figure 17.4 CHSWeekly (Source: eSignal. www.eSignal.com)
(See the description under the daily chart that follows)
ADXcellence
ADXquisite 255
Figure 17.5 CHSDaily (Source: eSignal. www.eSignal.com)
22 28
7
14
21
28
4
11
18
25
2
9
16
23
31 6
Mar
Apr
May
Jun
(CHS - CHICOS FAS INC,D) Dynamic,0:00-24:00
{4) ABC Retracement
32.3393
** t rtr
w *
(7) !
30.00
28.00
ADXquisite LONG ENTRY (Daily)
1. The weekly +ADX made a peak of greater than 25 (Figure 17.4).
2. Weekly prices retraced to the weekly 20 EMA.
3. The weekly -DMI did not cross the +DMI during the price retracement.
4. The daily chart makes an ABC retracement pattern.
5. The daily +DMI makes a cross and hold (+DMI is dominant).
6. Enter long on a pivot low reversal (up) near the 20 daily EMA.
7. Place a stop-loss under the pivot low at the 20 daily EMA.
Note: To the inexperienced trader s eye, this daily chart might look like a good
short entry at the lower low (C wave), but it is just the opposite. Notice that
prices dipped below the A wave low before reversing back up. The breakout in Ma
y cleared the old B highs.
ADXcellence
256 Chapter 17
Figure 17.6 OXYWeekly (Source: eSignal. www.eSignal.com)
Notice that price is above the weekly 20 EMA and trending up. In February throug
h April, 2004, the ADX makes a positive peak above 25 then falls as price retrac
es to the 20 weekly EMA. The -DMI does not cross +DMI during the price retraceme
nt.
ADXcellence
ADXquisite 257
Figure 17.7 OXYDaily (Source: eSignal. www.eSignal.com)
Here we see the ABC retracement on a daily timeframe. Note the C wave low in Jun

e goes below the A wave low in May. Then price breaks out above the B wave high
and pulls back to the 20 daily EMA. Our entry is made on the pivot low reversal
at the daily 20 EMA, and a stop-loss placed under the pivot low.
Note: This stock rose over 90% in fifteen monthsanother exquisite power trend tra
de. Don t rush your entry on this strategy. Stocks will have plenty of stored up
energy from traders who mistakenly went short on the lower C wave low.
ADXcellence
258 Chapter 17
Figure 17.8 TRBWeekly (Source: eSignal. www.eSignal.com)
ADXquisite SHORT ENTRY (Weekly)
(See the description under the daily chart that follows)
ADXcellence
ADXquisite 259
Figure 17.9 TRB Daily (Source: eSignal. www.eSignal.com)
ADXquisite SHORT ENTRY (Daily)
1. The weekly chart made a -ADX peak of greater than 25 (see Figure
17.8).
2. Price retraced up to the weekly 20 EMA.
3. The weekly +DMI does not cross the -DMI (or gain dominance) on the price
retrace.
4. The daily chart makes an XYZ retracement.
5. The daily -DMI makes a cross and hold, and prices retrace to the 20 EMA.
6. Because we have a cross and hold with price at the 20 EMA, enter short o
n a break of support.
7. Place a stop-loss above the pivot high at the 20 EMA.
ADXcellence
260 Chapter 17
Figure 17.10 $SPXWeekly (Source: eSignal. www.eSignal.com)
ADXquisite SHORT ENTRY (Weekly)
Study Case
In the Chapter 1 of this book, I gave an example of the S&P 500 at its top in 20
00 (Figure 1.4). I thought it would be appropriate to finish ADXcellence with th
e same chart.
We ve come a long way since 2000, and I hope you ve come a long way toward under
standing the excellence of ADX/DMI.
In the chart above, we see a trend reversal indicated by the lower high and lowe
r lows. Price retraced to the weekly 20 EMA. The -ADX peak was above 25 on the n
ew price low in December, 2000. Now let s take a look at the daily (Figure 17.11
).
ADXcellence
ADXquisite 261
Figure 17.11 $SPXDaily (Source: eSignal. www.eSignal.com )
ADXquisite SHORT ENTRY (Daily)
Study Case
The daily chart gives us a better picture of an XYZ retracement pattern. In Janu
ary, 2001, the Z wave extended slightly above the X wave. In early February, the
-DMI made a crossover high, giving us the green light to enter short on a retra
cement near the 20 EMA. Notice the two add to entry points in March.
The moral of this market story is: pay attention to your ADXcellence signals in
the future. Know what makes a valid entry signal, and then put the trade
And of course, always manage your risk.
ADXcellence
262 Chapter 17
ADXcellence
CHAPTER 18
ADXit
I have given you my truth about ADXcellence. And now, before I "exit" this treat
ise on my favorite indicator, I want to make a few more comments. Then I want to
talk briefly about truth and the trader s mindset.
The purpose of this book has been to expand upon the traditional uses of ADX/DMI

. With new terminology and new trading concepts, I wanted to bring the power of
ADX/DMI to a new level of understanding and appreciation.
I purposely spent a few chapters on momentum, trend, and volatility because I wa
nted ADXcellence to be viewed within the greater context of practical technical
analysis. The concepts in this book can easily fit into what you already know an
d do. The strategies have the power to enhance other trading approaches.
The truth is: I wouldn t trade without ADX/DMI. Most often, I only trade with pr
ice, ADX/DMI, and the 20 EMA. This simplifies my trading decisions.
And now I will discuss some truths of a different nature.
ADXcellence
264 Chapter 18
IN SEARCH OF XCELLENCE
Trading is a journey of self-discovery; success lies in understandi
ng
who you are.
When trying to improve as a trader, most people look outward; but the only way t
o succeed is to look inward. We all have strengths and weaknesses, and being tru
thful about ourselves is the key to becoming a great trader. Who and what we are
is not right or wrong, it is simply who we are. We have strengths and weaknesse
s, but how we manage them is essential to success in managing our trades.
Most traders trying to improve will first search out more gurus, better software
, and new trading systems. They suffer from "if only" syndrome. If only if I kne
w more, if only I studied more, had better picks, more computer screens, or a be
tter chat roomthen I could get it right. They look everywhere but in the mirror.
When their trading doesn t improve, they move on to more information, another sy
stem, or another guru. They will either run out of money or patience, or both. W
hat most traders lack is not information, but a deeper understanding of themselv
es and what they need to turn themselves into a success.
BELLS AND WHISTLES
If you can t trade with price alone, indicators won t help you.
Because of the new technology of computers and software, we are constantly barra
ged with vendors selling us the latest hot system of bells and whistles. Vendors
do not trade stocks, they trade dreams. Their job is to sell you a system of fl
ashing lights and buttons and convince you that you will be able to trade better
and fulfill your dreams of riches. In truth, if you cannot trade with price, th
en indicators won t help you. Most indicators are based on price.
ADXcellence
ADXit 265
Price matters most above all things. Never trade off indicators alone. Price is
the only truth you will ever find in the stock market. Price is where buyers and
sellers all agree at the same time. Price is exactly what the stock is worth no
w. You may think it is worth more or less, but price is telling you what is real
ly worth, whether you believe it or not. That is not to say it will remain at th
e same price, but traders must trade on what they see now, not what they hope to
see in the future.
ADX/DMI is an indicator found on most free charting platforms on the internet. Y
ou don t need expensive software to trade well. If you study price and trend, an
d follow the Power Trading Principles, you have what you need for a sound method
of trading.
BE YOUR OWN GURU
The purpose of trading is not to make money; the purpose of trading
is
to make the trader.
Traders without true confidence in their abilities and judgment will flock to ma
rket gurus for leadership. Following a market guru is the surest way to fail at
trading. A guru is not a mentor. A guru will lead you where you cannot go; a men
tor will guide you where only you can go.
Some market gurus complicate trading, and then they have you pay them to "uncomp
licate" it. A trader must build confidence on what they do best, not what others
do best. One of the most important lessons of trading is the need to be self-re

liant. There is only one trader whom you will ever trade like, and that is you!
The sooner you realize trading is about you and only you, the better off you wil
l be in the long run. That is not to say that you cannot learn a great deal from
others. Just make sure it is knowledge you own, not rent. And make sure it is n
ot simply information, but knowledge you can use to make you a better trader. Ma
king money is the stock market is not the result of trading; it is the result of
being a trader.
ADXcellence
266 Chapter 18
DISCIPLINE
You can t put into trading what your discipline leaves out.
Discipline is by far the hardest part of trading. Poor discipline will ruin the
best trading plans and the most brilliant assessments of technical analysis. No
matter how much you know, no matter how hard you work, you will always be at the
mercy of your self-discipline.
Poor discipline is knowing what to do and not doing it; knowing what not to do,
and doing it; or not knowing what to do, and doing anything.
Trading is a combination of knowledge, skill, and mindset. A proper trading mind
set is the catalyst for the other two. If you solve your discipline problems fir
st, the rest will be easier. Discipline is the hardest thing to change because w
e are genetically programmed to act and react in certain ways. Most traders only
face their discipline problems after the pain of losing becomes greater than pa
in of having to change.
THE EGO CHALLENGE
The worst trader you ll ever meet is your ego.
Let your ego trade when the market is closed. One of the biggest barriers for le
arning to trade is the trader s ego. Ego can t read a chart; ego likes to "go fo
r it" and "take a shot." Ego will lie to you in order to keep trading. Ego doesn
t listen and doesn t care about your account balance.
Ego hates truth and has to be right, even when it is wrong. When traders invest
in their ego, there is more riding on the trade than money, and it becomes harde
r to take a loss. One of the greatest skills a trader can possess is the ability
to admit they are wrong and to do it without harsh self-criticism.
ADXcellence
ADXit 267
CONTRARIAN NON-THINKING
A room full of contrarian thinkers is a crowd.
Never use contrarian thinking as an excuse to trade against price and trend. In
a downtrend, it is not contrarian thinking to go long because the crowd is short
. A true contrarian thinks independently of the crowd, not simply contrary to it
.
No one knows what the crowd is thinking. Focus on what you see in price and tren
d, and ignore trying to outsmart the market. Contrarian thinking is usually nonthinking, and it stems from a lack of confidence and a belief the market must be
tricked or outsmarted. Trade with the crowd of technical signals in the chartthe
y have gathered in your trading room for a reason.
RISKY BUSINESS
In trading, you win by not losing.
If you can t manage your risk, it doesn t matter how much you know about trading
. Risk management is not a flashy topic, but understanding how to mange risk, us
e leverage, and manage trades is essential to reaching the next level.
Trading is not for everyone. If you have too many big losses, you won t enjoy tr
ading; and you ll quit in despair. Most people underestimate the emotional pain
associated with big losses, and few beginners are prepared for the stress of mak
ing decisions with money on the line.
Trading is not for solving life s problems. It is not an answer to a lost job, a
financial crunch, or a way to get rich overnight. Trading is risky, and having
to make money will cause judgment errors and poor risk management. Trading is a
skill that takes time to acquire.
ADXcellence

268 Chapter 18
FINAL THOUGHTS
As a student, we first learn our profession.
As a teacher, we begin to understand what we have learned.
I hope you enjoyed reading ADXcellence as much as I did writing it. I learned a
great deal in the process, and I am happy to share the ADXcellence principles an
d strategies with you.
ADXcellence tells us when to get in a trade and when to stay out. It keeps us on
the right side of trend direction and keeps us trading with the strongest trend
s. Following the principles and strategies in this book will reduce the stress o
f trading decisions and improve results.
If you study and follow the ADXcellence system, I believe you can elevate your t
rading to a higher level and reach your financial goals.
I wish you the best, and I hope you truly Xcel in your trading career.
ADXcellence
APPENDIX
Calculations
This chapter provides a more detailed presentation on the formulas and calculati
ons for ADX and DMI. See Chapter 2 for a more conceptual explanation.
DIRECTIONAL MOVEMENT (DM)
Directional Movement (DM) is the largest part of today s range that is outside o
f yesterday s range. When the largest part of today s range is above yesterday s
range, we get positive DM (+DM). When the largest part of today s range is belo
w yesterdays range, we get negative DM (-DM).
ADXcellence
270 Appendix
Directional Movement takes into consideration every possible configuration that
can occur between two days.
1.
On days where price makes a higher high and higher low, DM is mea
sured as the difference between today s high and yesterday s high. This is calle
d positive DM (+DM).
2.
On days where price makes a lower high and lower low, DMI is meas
ured as the difference between today s low and yesterday s low. This is called n
egative DM (-DM).
3.
Outside days make higher highs and lower lows and will have both
a (+DM) and a (-DM). Use the larger of the two values.
4.
Inside days make neither a higher high nor a lower low and will h
ave zero DM because there is no range outside of yesterday s range.
5.
On limit up days, the +DM is the difference between today s limit
and yesterday s high.
6.
On limit down days, the -DM is the difference between today s lim
it and yesterday s low.
DIRECTIONAL MOVEMENT INDICATOR (DMI)
The Directional Movement Indicator (DMI) is created by measuring DM relative to
True Range (TR). DMI represents the percent of the true range that is positive f
or the day or negative for the day. DMI is always positive or negative for a giv
en day. There cannot be directional movement both up and down in the same day.
ADXcellence
271
Before we make that calculation, let s define True Range. True Range is always a
positive number and defined as the largest of the following:
1.
The distance between today s high and today s low.
2.
The distance between today s high and yesterday s close.
3.
The distance between today s low and yesterday s close.
To calculate DMI
for one (1) day, we divide directional movement by True
Range:
+DML- +DMi TRi
-DMIi = -DMi TRi
DMI for one day is not useful, so DMI is based on a period of time during which
DMI values are recorded. The default period is fourteen (14) days. The DMI is me

asured for fourteen consecutive days and added together to get a sum (+DMIh). Ch
arting software makes these calculations automatically and updates the resulting
value each day.
The calculations are expressed as follows:
+DMI14 =
+DM14
TRl4
-DMI14 =

-DM14

TR14
ADXcellence
272 Appendix
AVERAGE DIRECTIONAL MOVEMENT INDEX (ADX)
The Average Directional Movement Index (ADX) is based on DMI using the following
calculations:
Calculate the difference between +DMI14 and -DMIm.
DMIl4 diff = (+DMI14) - (-DMI14)
Calculate the sum of +DMI14 and -DMI14.
DMI14 sum = (+DMI14) + (-DMI14)
Calculate the Average Directional Movement Index (ADX)
ADX =
(DMI14 diff / DMI 14 sum) * 100
Multiplying by 100 normalizes the ADX value, so it falls between a range of zero
and 100. This makes ADX an oscillator indicator.
ADX measures the range expansion of prices and provides an objective value of ho
w strongly prices are trending. The higher the ADX, the stronger prices are tren
ding; the lower the ADX, the weaker prices are trending. The default value for A
DX is (14) when based on DMI (14); however other periods can be used.
FURTHER INFORMATION
For a further explanation of ADX and DMI calculations, I recommend you read Wild
er s original work, Section IV (pages 35-52), New Concepts in Technical Trading
Systems.
ADXcellence
ABOUT THE AUTHOR
Dr. Charles B. Schaap is a full time trader in stocks, options, and futures. Whe
n not trading, he teaches seminars on technical analysis and trading strategies.
His Trading with Xcellence seminar is given once a year in Las Vegas. Dr. Schaa
p has written numerous articles for magazines and newsletters publications inclu
ding Technical Analysis of Stocks & Commodities, SFO, and Working-Money. Dr. Sch
aap is the creator of "The 50-50 Strategy," a popular trading strategy that emph
asizes low risk entries into emerging stock trends. He has hosted the TraderDoc
radio show in Las Vegas. At StockMarketStore.com, he provides market analysis an
d writes on trading topics. Dr. Schaap has a special interest in the trading min
dset and is a sought after speaker on the subject of personal trading psychology
. He is a regular speaker at various investment groups such as the International
Traders Expo and the American Association of Individual Investors. His educatio
nal website is www.traderdoc.com.
Dr. Schaap welcomes your comments and questions. He can be contacted at traderdo
c@traderdoc.com.