The Direction of the Stock Market Trend and its Potential to Strengthen
When I started testing and developing trading systems two decades ago, I didn't approach it as the typical data-mining Quant, but instead as a trading practitioner. I was already a chartist and focused on directional price trends. I just wanted to quantify the edge.
Quantifying an edge requires testing the entry/exit/size system to determine its mathematical expectation. Are the average profits > average losses? ie. Does it generate asymmetric investment returns? You can probably see why I trademarked it.
Naturally, I started with the "technical" indicators I had already been using for asymmetric payoffs.
Technical indicators are price-based equations designed to measure trend direction and strength.
At the time, many of the patterns were difficult to test, thus indicators.
Instead of reinventing the wheel and going on a data mining fishing expedition, I focused on publicly known indicators, and my favorites were developed in 1978 by J. Welles Wilder. Average Directional Movement (ADX) was one, and it measures a trend's strength and direction.
The Average Directional Index (ADX), Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI) These three factors combined indicate the direction and strength of the trend.
The foundation of the Directional Movement System is positive and negative directional movement. Wilder's ADX calculates the direction of movement by comparing the distance between two consecutive lows to the distance between each low's corresponding high.
Directional movement is + when the current high - the prior high is greater than the prior low - the current low. +DMI = the current high - the prior high (if it's +). -DMI is - when the prior low - the current low is > than the current high - the prior high +DMI is green:
+DMI is green for positive directional movement. -DMI is red for negative directional movement. ADX measures the strength/weakness of a trend, not its direction.
All that to get to an interpretation of today's S&P 500. Uptrending green is showing positive directional movement, but just as important, it's coming from a very low ADX. Buying pressure is dominant when +DM > -DM Low ADX signals recent weakness, with room to strengthen.
No indicator is perfect, and neither is ADX/DMI. It's just a mathematical way to quantify trend direction and strength.
It's a reminder to me that if this is a new uptrend, it's from a lower (risk) starting point with much room to run if it will...
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Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.