Friday, March 15, 2013

A Volume Biased ADX

I am returning to blogging after a long hiatus.  It is usual in life that we face intervals of disturbing events and confused priorities.   Now that the dust is settling down I am slowly picking up the threads and I am coming back to my passion, Technical Analysis.

I am  sharing some thoughts on the ADX indicator. ADX is one of the very popular indicators and widely used by technical analyst. Dr. Charles Schaap’s  book “ADXcellence” deals with different strategies of trading with ADX. Then there a commercial product called Super ADX which the sellers claim is a leading indicator though the ADX by itself is a lagging indicator. Also I do not know how much of it is based on real ADX other than they have an indicator called supporting ADX. Anyway soon I will release a clone of the so called Super ADX.  I also had released a Gaussian smoothed ADX called KADX which was more sensitive and smoother than the conventional ADX. ADX is a useful indicator to measure the strength of a trend. ADX by itself is a non directional Indicator and does not indicate if the trend is up or down. We use two other indicators called the +DI and -DI to reveal which trend direction. I will not go into further details as most of you, readers of this blog, will be familiar with the ADX indicator.

As many of you may be aware the importance I provide for the volume in my analysis. Any move of a stock which is not aided by volume will not last. Volume is the fuel for any trend. So naturally any trend strength indicator without consideration of the volume cannot provide the real picture. The ADX calculation totally ignores volume and purely based on the price movement.  Price action combined with volume would be definitely provided a more realistic picture. This thought has inspired to experiment with the ADX to include the volume aspect.  The basis for the ADX calculation are the difference between the High of a day and the High of the previous day and also the difference between the low of the day and low of the previous day. In other words it uses the momentum of the Highs and Low. This momentum is fuelled by volume. So we will add a volume factor to this momentum. To calculate the volume factor we take the ratio of the current volume and the average volume. We will bias the momentum of the Highs and Lows with this volume factor. The remaining of the calculation will be based on these biased values and the final ADX, +DI and –DI values will be biased by volume. The result of this is quite evident from the chart below. The resultant +DI and –DI are much more responsive to the volume and they clearly indicate which moves are volume driven and which are not.  The ADX also quickly increase in values when the volume increases indicating increased trend strength.