Stocks & Commodities V17:10 (433-439): How The Pros Use A verage Directional Index by Barbara Star, Ph.D. Copyright (c) Technical Analysis Inc. CLASSIC TECHNIQUES How The Pros Use A ver age Directional Index Here’s how technicians Charles L eBeau, Paul Rabbitt, an dLinda Bradford Raschke integrate the average directional index into their trading plans. ow would you like to look over the shoulders ofprofessional traders using one of your favorite indicators? Here’s your chance. I spoke with three well-known traders who put their own money at risk daily. I asked them to show me what they do with the average directional index (ADX), one of the longest-lived and most p opu- lar trend indicators around. I asked Charles LeBeau, Paul Rabbitt, and Linda Raschke how they integrate ADXinto their own trading analysis and trading tactics. Here, largely in their own words, these traders explain the thinking that guides their decision- making. Hopefully, some of their strategies might make you think about how this indicator can improve your trading. PAULRABBITT Paul Rabbitt is a well-known quantitative strategist. During his 20-year affiliation with the Oppenheimer Co., h e created and ran their quantitative department. He also developed the “Q” stock ranking system, a 12-factor stock risk/return model. He was a senior portfolio strategist when he left the firm in 1998 to form his own company. Currently, he advises insti- tutional clients and provides sector and industry forecasts. Rabbitt’s analyses and investments include stocks, bonds, various financial indices, and Spyder sectors. Market com- ments and quantitative rankings on individual stocks are available on his Website. (For the URL, see “Related re- sources” at the end of this article.) Rabbitt uses a 14-unit ADXwith end-of-day data as a rough gauge of momentum. “I use a very s implistic interpretation ofADX. If I have a rising ADX, but it is only at the 15 or 20 level, I consider it a weak momentum situation. If it is above 30, I consider it a stronger momentum situation. Even if A DX changes direction, as long as it remains above 30, I regard it as a momentum situation. And the higher the level, the greater the strength of the momentum. I don’ t try to refine ADX too much,” he comments. Entries and exits: Given his background, Rabbitt relies on fundamentals, such as earnings announcements, earnings H by Barbara Star, Ph.D. FIGURE 1: RABBITT TEMPLATE, XOI OIL AND GAS INDEX. Paul Rabbitt’s screen template shows both the overall pric e action and the indicators at the same time. The original template consists of a black background, white price bars, and yellow trendlines. Those colors were changed for this article to provide better contrast. FIGURE 2: 3COM CORP.ADX above its 30 level indicates a strong trend is in progress. In this case, the trend is clearly down. Rega rdless of price direction , in a trending mode, Rabbitt focuses on the moving averages and disregar ds all other indicators until ADX moves below 30. Once below, he would turn to the RSI and Bollinger bands to track price movement. surprises, or company developments to form the basis for selecting buy or sell candidates. Then he looks at his technical tools. ADXhelps determine entry and exit points on preselected securities. “ADXis the accelerator/decelerator in the trading process. ADXdoes not dictate whether I stay in or out of a trade,” he goes on to say. “ADXonly postpones a sale or accelerates a sale or postpones a purchase or accelerates a purchase. M E T A S T O C K ( E Q U I S I N T E R N A T I O N A L ) Longer-term daily chart ADX above 30 Bollinger band w/ 30-unit EMA RSI Price down trend ADX above 30
