The ASX market has undergone a dramatic trend change since mid-May and today we discuss a simple method that will allow you to hang on to the trend.
Big money can be made when you identify a trend and stick with it. One highly-regarded method utilises the Welles Wilder’s Directional Movement indicator, which was designed to identify trends when they occur and monitors the trend strength as it unfolds. This indicator is available in the D2MX Chart tool in the d2mxIRESS trading platform. (You’ll also find it in Market Analyser and The Bourse.)
The Directional Movement System measures the ability of bulls and bears to move price outside the previous day’s trading range. The system consists of three lines:
• The Positive Direction Indicator (+DI) summarises upward trend movement (GREEN);
• The Negative Direction Indicator (-DI) summarises downward trend movement (RED); and
• The Average Directional Movement Index (ADX) indicates whether the market is trending or ranging (BLACK).
The Average Directional Movement Index
The Average Directional Movement Index (ADX) is the key to the system. A declining ADX shows that the market is losing direction. When the ADX falls below both +DI and -DI it signals a lifeless market. Do not trade with DMS until the ADX has clearly turned off the bottom. Dr Elder suggests waiting until the ADX rises 4 steps off its low (e.g. ADX rises to 19 from a low of 15). The longer that the ADX has remained below both +DI and -DI the stronger the subsequent trend is likely to be.
When the ADX rises above both +DI and -DI it signals that the market is becoming overheated. Take profits when the ADX turns downwards from above +DI and -DI.
Simplified Elder Trend System
Dr Alexander Elder in his book “Trading for a Living” outlined a straight forward application of the system:
Go LONG when +DI is above -DI and either:
• ADX rises while +DI and ADX are above -DI; or
• ADX turns up from below +DI and -DI.
Exit when +DI crosses below -DI.
Go SHORT when -DI is above +DI and either:
• ADX rises while -DI and ADX are above +DI; or
• ADX turns up from below +DI and -DI.
Exit when -DI crosses below +DI.
Be aware that if the ADX is falling then the trend is losing momentum.
Use stop-losses at all times!!
D2MX Filter For The Simplified Elder Trend System
I suggest that you add an additional filter to this system, which has worked exceptionally well in the past 12 months (see examples below).
Only trade to the long side when the 13-day moving average is above the 50-day moving average, and exit when the price has closed above/below the 13-day moving average in two consecutive sessions by either exiting on the close or at the open of the following session.
CHART 1: Wesfarmers trend has changed
The Simplified Elder Trend System with D2MX Filter has produced some handsome profits in Wesfarmers over the past 12 months, and as you can see the trend has now turned down, so you would be using the 13-day moving average filter for your trailing stop.
CHART 2: Qantas trend has changed recently
Qantas produces some great trends. The Simplified Elder Trend System with D2MX Filter has produced some handsome profits in Qantas (both Long and Short) over the past 15 months, and as you can see the trend has now turned down, so you would be using the 13-day moving average filter for your trailing stop.
The ASX 200 index is what everyone watches on a daily basis. The Simplified Elder Trend System with Filter has produced some decent profits in the ASX 200 over the past 6 months and as you can see the trend has now turned down (since late May), so you would be using the 13-day moving average filter for your trailing stop.
The Simplified Elder Trend System with D2MX Filter outlined here will not give clear signals if the market is trading sideways.
Big money is made by identifying a trend early and sticking with it. This Simplified Elder Trend System with D2MX Filter outlined here offers you a straight forward system for sticking with the trend.
It is often said that “the trend is your friend” and to “trade with the trend”, and the past 12 months have been ideal for trend trading systems. However trading with the trend requires discipline and it is very tempting to try to pre-empt the trailing stop process, but only by following the system will the trades develop to their full potential.
Options can be used to help you manage the trailing stop process with discipline and to reduce your risk. Utilise the features in the d2mxIRESS software to trade plan your trades for the particular trade using your specific trading system. You will save time and potentially reduce your trading risk.
For more trade ideas and recommendations on how to trade in this market, sign up for a free trial of the D2MX Daily Trading Report, which provides a daily serving of insightful market analysis and trade recommendations from the D2MX Advisory team, including:
• Trade ideas and strategies
• Dividend enhancement strategies
• Market scans to watch
• International market analysis, and
• Highlights from the S&P/ASX 200
Investment Adviser – D2MX Advisory
This report was prepared by Michael Hevern. It represents the views and opinions of the author. It is not intended for use by any third party, without the approval of Michael Hevern. While this report is based on information from sources which are considered reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect my judgment at this date and are subject to change. Contracting Hevern Pty Ltd is a Corporate Authorised Representative No. 408868 of D2MX Pty Limited ABN 98 113 959 596, AFSL No. 297950 (D2MX), and Michael Hevern has been appointed as an Authorised Representative of Contracting Hevern Pty Ltd. Opinions, conclusions and other information expressed in this report are not given or endorsed by D2MX, unless otherwise indicated. The information contained in this Report is General Advice only, as the information or advice given does not take into account your particular objectives, financial situation or needs.
Disclaimer: Using leverage to invest can be a two edged sword, as it can magnify your returns when the stock price rises, but will in turn magnify the losses if the trade does not perform as expected.