The average direction strength index (ADX) measures the strength of a trend. Similar to the RSI, the ADX fluctuates between 0 and 100. A number of 20 and below indicates a weak trend while a number above 50 indicates a strong trend. If the ADX indicates a strong upward trend, it can signal to an investor that it is ok to enter the market because the price will continue to rise. If the ADX starts to fall below 50 then an investor might sell because a downward or sideways trend is underway. ADX is available on most trading platforms.
Algorithmic or “algo” trading uses predetermined criteria to execute trades without any human involvement. An algorithm processes data and executes trades in a fraction of a second. Since the computer is able to move so quickly, it can place the trade at the best time. Another advantage to algo trading is the accuracy and lack of human error when typing in or entering the trade. Lastly, algo trading takes away the emotion which can cause people to make irrational choices. The computer will only buy and sell according to the algorithm. A disadvantage to algorithmic trading is the technical sufficiency required to write algorithms. A prerequisite for writing algorithms is knowing complex programming languages which can take a while to learn. The other drawback to algorithmic trading is the lack of control. The quality of the trades made is dependent on the program and the algorithm, so traders lose control of the process.
Elliott Wave Theory
Nelson Elliott developed the Elliott Wave theory to provide predictability in price movements. Elliott believed that price moved in repetitive patterns based on investors’ emotions. He defined the up and down swings as waves. These wave patterns can occur from minute to minute or from decade to decade. The Wave Theory stipulates that traders will catch onto a trend and push prices up. When a price is high enough, people will exit the trade to take the profit. A trending market moves in a 5-3 wave pattern where the first five waves are called impulse waves. Impulse waves 1, 3, and 5 are motive waves, while impulse waves 2 and 4 are corrective waves. The motive waves represent the traders jumping onto a trend and pushing prices up. The corrective waves occur when investors decide to exit the trade and take their profits which causes price to lower. These 5 waves are followed by 3 corrective ABC waves. There are 21 types of corrective ABC waves. These waves move in the opposite direction as the impulse waves.
Fibonacci Retracement levels help identify support and resistance levels. The first step in determining support and resistance zones is selecting a swing high and a swing low point. A swing high is a candlestick that lower highs to the left and to the right. A swing low is a candlestick with higher lows to the left and right. To build the Fibonacci retracement levels, a trader will select a recent and significant swing low and connect it to a recent and significant swing high. After this, the trading platform will generate the Fibonacci retracement levels. It is not a guarantee that Fibonacci levels will become support and resistance zones. This is partly due to the subjectivity of selecting swing high and lows. If the price movement does find support and resistance zones at Fibonacci levels, a trader can use this information to decide when to enter the market.
Moving average convergence divergence (MACD) is a tool that uses moving averages to identify patterns. The graph will show two lines and a histogram. One line is calculated based on faster moving averages while the other line is based on slower moving averages. The histogram plots the difference between the faster and slower moving averages. The faster line will converge and diverge with the slower line, indicating future trends. If the faster line crosses below the slower line, it indicates a downward trend whereas if the faster line crosses above the slower line, it indicates an upward trend. The farther the fast line passes above or below the slow line, the stronger the trend. The distance between the fast and slow lines is represented by the histogram. MACD uses past information to calculate moving averages. Because of this, the data generated by MACD tends to lag behind current price movements. MACD is available on most trading platforms.
Pivot points function like Fibonacci levels in that they locate potential support and resistance levels. Pivot points, however, are not as subjective to a trader’s judgment because they do not require the trader to determine the swing high and swing low points. Pivot points are calculated using the last trading session’s high, low, open, and close.
Wells Wilder developed the relative strength index (RSI) as a tool to determine whether an asset is overbought or oversold. RSI is scaled from 1 to 100 and if an asset reaches 70 it is considered to be overbought. On the other hand, if the asset falls below 30 it is considered to be oversold. If an asset is overbought it means that there are no more buyers. This will cause the asset price to fall. In this scenario, it could be a good opportunity to short the asset. If an asset is oversold, there are no more sellers left in the market so asset price will rise. In this situation, it is a good time to buy the asset because it is likely that the price will go up. The RSI can also help to confirm trends. An RSI of above 50 signals an upward trend while RSI below 50 signals a downward trend. RSI is available on most trading platforms.