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Thursday, April 12, 2012

ADX indicator

 I apologize for the size of these charts in advance.  I needed to show a lot of years to make it clear.  You can always double click on the image to make it bigger if you have trouble seeing them.
Besides moneystream, ADX is another useful indicator for determining secular bull or bear markets.  This indicator is a mathematical expression of trend strength.  In the middle panel of the chart below, you can see the indicator consists of 3 lines.  The green line is essentially buying power, the red line is selling power, and the blue line is the strength of the trend.  If the green line is above the red line, the blue line is measuring the strength of the uptrend.  When the red line is on top, the blue line is showing the strength of the down trend.

The Dow sold off into 1942 as WW2 was raging.  The blue line started rising sharply in 1940 indicating the down trend was getting stronger.  The rally that started in 1942 was very strong.  A previous post showed how moneystream reacted positively on that rally.  The blue line turned up strongly in 1943 indicating the uptrend was getting stronger.  By the time the Dow peaked in 1946 the blue line was quite high.  It was well above the last peak made in the down move in 1942.  That was a powerful move up.  This was a good sign the market was transitioning out of secular bear to secular bull.  During the subsequent pullback into 1949, the blue line dropped.  This indicated the down trend was not strong this time.  That was further evidence the secular bear market was ending.  Points A-F on the chart show the blue line consistently going up on up moves and down on down moves.  This is normal secular bull market behavior.

Now we will see how the ADX behaves when the market transitions back to secular bear.  Point A in the chart below shows the blue line going up while the market went down.  This was the first warning sign the secular bull could be over.  The rally off the 1966 low shows the blue line dropping as the Dow retested its 1966 high.  This was another warning sign for the market.  Points B-D show the blue line going up consistently on the down moves in the Dow.  The hallmark of a secular bear market.  Notice the sell off in 1981 and 1982 has the blue line flat.  This was the first down move in over a decade that did not show a strong trend.  This was the first sign that the secular bear market might be coming to an end.  The rally off the 1982 low left absolutely no doubt about that as the blue line rose sharply.  That was a strong rally and the secular bull market was off and running.

The pattern in the 80s and 90s was typical of a secular bull market.  Notice at point A in the next chart how the blue line dropped during the crash of 87.  Even though the moneystream showed considerable damage, as I showed in a previous post, the downtrend was not strong.  The up move in the early 90s did not have much trend strength as the blue line was very subdued.  However, it never picked up on any down moves either. There was no sign the secular bull was ending.  In the late 90s, the market took off and so did the blue line indicating the trend was again very strong. Notice that after point B in 1996, the blue line started drifting down.  Even though the market was still rallying furiously, the trend was not as strong.  I find this rather odd behavior when you look at how fast the market was going up.  In hindsight, I guess that was a bit of a warning sign.

The bear market that started in 2000 was a strong downtrend.  Notice how the blue line rose sharply into point C in the chart above.  When combined with the damage in the moneystream indicator in the bottom panel, it clearly shows the secular bull market was in trouble.  The market recovered with the Dow actually making a new high into the top of 2007.  SPX only managed to test its 2000 high, and the NASDAQ was nowhere near its old high.  The secular bear was having an affect that few people noticed.  The blue line moved up some in 2007, but  notice the peak was still well below the peak at point C.  The last down move was still a stronger move.  If the market had continued up and the blue line gotten stronger, or had it dropped during a pullback in the market, it could have been a positive sign for the end of the secular bear market.  However, that did not happen.  The ADX did not give any clear sign the secular bear was ending.  At point D we can see the move down from 2007 was another very strong downtrend.  That move reinforced that we were still in a secular bear market.  The moneystream in the bottom panel was really crushed on the monthly charts, just like it was in the quarterly charts I showed in a previous post.  That brings us up to the current situation.  As you can see the blue line has been falling this entire rally.  It is now at historically low levels, indicating this up move is not a strong uptrend yet.  The moneystream has barely recovered at all.  There clearly is no sign the secular bear market is over yet.

These charts show that the combination of moneystream and ADX are very powerful in determining what the market is doing in the big picture.  We can see that the market goes through cycles where buy and hold investing works and cycles where it doesn't.  It is also clear we are still in one of those cycles where it doesn't.  I believe there is still considerable downside risk in today's market.   The moneystream indicator is downright scary.

That wraps up the big picture analysis of where we are at now.  From here on out I will be discussing current things I see going on in the markets.


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The information in this blog is provided for educational purposes only and is not to be construed as investment advice.