Blog: Market Analysis

The Average Directional Index (ADX) is a technical analysis indicator used by traders to gauge the strength of a trend, regardless of its direction.

The ADX is often accompanied by two other indicators, the Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI), which together help traders determine whether to go long, short, or avoid trading altogether.

Understanding the ADX Calculation

Calculating the ADX involves a series of steps due to the presence of multiple lines in the indicator. The steps are as follows:

Calculate +DM, -DM, and True Range (TR) for each period:
- +DM = Current High – Previous High
- -DM = Previous Low – Current Low
- TR is the greater of the current high minus the current low, current high minus the previous close, or current low minus the previous close.
Smooth the 14-period averages of +DM, -DM, and TR:
- The smoothing process involves summing up the first 14 TR readings and then updating them with new TR values while dropping the oldest.
Calculate +DI and -DI:
- +DI = (Smoothed +DM / Smoothed TR) * 100
- -DI = (Smoothed -DM / Smoothed TR) * 100
Determine the Directional Movement Index (DMI):
- DMI = (| +DI – -DI | / | +DI + -DI |) * 100
Calculate the ADX:
- The ADX is calculated by smoothing the DX values over a set number of periods, typically 14.

Interpreting the ADX

The ADX, along with the +DI and -DI, provides traders with essential information about the trend strength and direction:

Strong Trend: An ADX above 25 indicates a strong trend, which could be either upward or downward.
Weak or Non-Trending Market: An ADX below 20 suggests a weak trend or a market that is trendless.
Trade Signals: Crossovers between the +DI and -DI lines can signal potential trading opportunities. For example, if +DI crosses above -DI and the ADX is above 25, it may be a buy signal. Conversely, if -DI crosses above +DI under the same conditions, it may signal a short trade.

ADX vs. The Aroon Indicator

While the ADX indicator includes three lines (+DI, -DI, and ADX), the Aroon indicator consists of only two.

Both indicators aim to identify trend direction and strength, but they use different calculations, which may result in different crossover signals.

Limitations of the ADX

The ADX can produce frequent crossovers, leading to potential confusion or losses if trades are entered based on false signals.

These are particularly common when the ADX is below 25.

To mitigate these issues, the ADX is best used alongside other technical indicators and price analysis.

FAQs

What is a good ADX value? An ADX above 25 is generally considered strong, indicating a significant trend. Below 20, the trend is weak or non-existent.
Is the ADX a good indicator? Yes, particularly when combined with price action analysis and other indicators, the ADX can effectively measure trend strength and direction.
What indicators work well with the ADX? The Relative Strength Index (RSI) is often used with the ADX. While the ADX measures trend strength, the RSI can assist with timing entries and exits.

Concluding Thoughts

The Average Directional Index (ADX) is a valuable tool for technical traders seeking to assess the strength and direction of trends.

When used correctly, it can help traders determine whether a market is trending or ranging and guide them in selecting the appropriate trading strategy.

Although the ADX is effective on its own, combining it with other technical indicators like the RSI or moving averages can further enhance its usefulness in a trading strategy.

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Weekly Market Wrap: Is Nvidia & the Tech Sector too Overbought?

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Market Recap & Upcoming Week

Last week witnessed significant developments in the tech industry, particularly surrounding Nvidia. The company, known for its pioneering role in AI technology, had earlier set the stage with an impressive revenue forecast that captured Wall Street’s attention.

With heavyweights like Microsoft and Alphabet backing AI’s potential, Nvidia’s anticipation of its Q2 results became a major focal point. As the tech juggernaut predicted sales of $12.4 billion for the quarter, all eyes were on them to see if they could live up to this forecast amidst challenges like potential GPU shortages and market shifts.

Moreover, the AI-driven surge that Nvidia demonstrated truly paid dividends. They announced a staggering $13.5 billion revenue for the fiscal second quarter, primarily driven by the increasing demand for their latest AI chips. This robust performance not only exceeded expectations but also elevated the firm beyond the coveted $1 trillion valuation threshold.

Their stronghold in the data center space has, however, garnered attention from competitors. Nvidia’s unprecedented success now faces challenges from rivals like Advanced Micro Devices, while tech behemoths like Google and Amazon are considering their own chip solutions.

In the upcoming week, financial enthusiasts should keep a keen eye on the U.S. market landscape, focusing especially on pivotal indicators such as inflation, jobs, and home prices.

Key corporate results from giants such as Pinduoduo, Hewlett Packard, Best Buy, Salesforce, and others will roll out, potentially offering a fresh perspective on market dynamics.

On the data front, the JOLTS report on Tuesday, ADP’s Employment Report on Wednesday, and the significant nonfarm payrolls report on Friday are set to provide insights into the U.S. employment scenario.

Furthermore, with the release of the Case-Shiller National Home Price Index and the BEA’s PCE Price Index, market participants will gain clarity on the housing sector and the inflationary trajectory—two crucial components that heavily influence the Fed’s policy decisions.

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USDSGD – Looks like the trading range is still intact, after prices failed to break out of the range to the upside.

NASDAQ 100 (US100) – The pullback (~9%) might be over, good chance of prices heading to test prior highs.

Gold (XAUUSD) – Low risk buying opportunity after a long pullback.

Bitcoin (BTCUSD) – RSI extremely oversold, good chance of a bullish rebound.

Spencer Li

Spencer is an avid globetrotter who achieved financial freedom in his 20s, while trading & teaching across 70+ countries. As a former professional trader in private equity and proprietary funds, he has over 15 years of market experience, and has been featured on more than 20 occasions in the media.

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Tweezer Top & Tweezer Bottom Pattern

What Is a Tweezer?

A tweezer is a technical analysis pattern, commonly involving two candlesticks, that can signify either a market top or bottom.

Understanding Tweezers

Tweezer patterns are reversal patterns that occur when two or more candlesticks touch the same bottom for a tweezer bottom pattern or when two or more candlesticks touch the same top for a tweezer top pattern.

Tweezer bottoms are considered to be short-term bullish reversal patterns.

Tweezer tops are thought to be bearish reversals.

Essentially, with both formations, either buyers or sellers were unable to push the top or bottom any further.

Both types of patterns require close observation and research to be interpreted and used correctly.

A bearish tweezer top occurs during an uptrend when bulls push prices higher, often ending the day near the highs, which is generally considered a strong bullish signal.

On the following day, traders reverse their market sentiment.

The market opens, does not breach the prior day’s highs, and heads straight down, often eliminating most of the prior period’s gains.

Conversely, a bullish tweezer bottom is realized during a downtrend when bears continue to drive prices lower, closing the day near lows, which is usually a strong bearish trend.

Day 2 is a reversal, as prices open, do not breach the prior day’s lows, and head sharply higher.

A bullish advance on Day 2 can quickly eliminate losses from the previous trading day.

A tweezer top is identified by two candles with similar highs occurring back to back.

A tweezer bottom would see two candles with similar back-to-back lows.

Special Considerations

As an investment strategy, tweezers offer traders a level of precision when seeking to take advantage of market trends.

While tweezers can take on a variety of appearances, they all have a couple of traits in common.

Sometimes appearing at market turning points, these candlestick patterns can be used for analysis purposes—to simply indicate the possibility of a reversal—or they can be used within a broader context of market analysis to provide trade signals for trend traders.

Tweezers were made mainstream in Steve Nison’s popular candlestick charting book Japanese Candlestick Charting Techniques.

Candlestick methods are characterized by the body of a candle, which is created by the difference between the open and close, while the thin “shadows” on either end of the candle mark the high and low over that period.

Typically, a dark or red candle indicates the close was below the open.

A white or green candle highlights the price closing higher than it opened.

Concluding Thoughts

Tweezer patterns are important tools in technical analysis, providing signals for potential reversals at market tops and bottoms.

While these patterns can be effective, they should always be used in conjunction with other indicators or market signals to confirm the trend reversal.

Understanding and correctly interpreting these patterns can give traders a strategic edge in identifying short-term market shifts.

Three Outside Up & Three Outside Down Pattern

The three outside up and three outside down are three-candle reversal patterns that appear on candlestick charts. The pattern requires three candles to form in a specific sequence, showing that the current trend has lost momentum and might signal a reversal of an existing trend.

In particular, the pattern is formed when a bearish candlestick (one that closes lower than it opened) is followed by two instances of a bullish candlestick (which closes higher than it opens), or vice versa.

The three outside up and three outside down may be compared with a three inside up/down candle.

How 3 Outside Up/Down Candlesticks Work

The Three Outside Up Pattern

The market is in a downtrend.
The first candle is bearish.
The second candle is bullish with a long real body and fully contains the first candle.
The third candle is bullish with a higher close than the second candle.

The Three Outside Down Pattern

The market is in an uptrend.
The first candle is bullish.
The second candle is bearish with a long real body that fully contains the first candle.
The third candle is bearish with a close lower than the second candle.

The first candle marks the beginning of the end of the prevailing trend as the second candle engulfs the first candle. The third candle then marks an acceleration of the reversal.

The three outside up and three outside down patterns occur frequently and are reliable indicators of a reversal. Traders can use these indicators as primary buying or selling signals but still watch for confirmations from other chart patterns or technical indicators.

3 Outside Up Trader Psychology

The first candle continues the bearish trend, with the close lower than the open indicating strong selling interest while increasing bear confidence. The second candle opens lower but reverses, crossing through the opening tick in a display of bull power. This price action raises a red flag, telling bears to take profits or tighten stops because a reversal is possible.

The security continues to post gains, lifting the price above the range of the first candle, completing a bullish outside day candlestick. This increases bull confidence and sets off buying signals, confirmed when the security posts a new high on the third candle.

3 Outside Down Trader Psychology

The first candle continues the bullish trend, with the close higher than the open indicating strong buying interest while increasing bull confidence. The second candle opens higher but reverses, crossing through the opening tick in a display of bear power. This price action raises a red flag, telling bulls to take profits or tighten stops because a reversal is possible.

The security continues to post losses, seeing its price drop below the range of the first candle, completing a bearish outside day candlestick. This increases bear confidence and sets off selling signals, confirmed when the security posts a new low on the third candle.

Concluding Thoughts

The three outside up and three outside down patterns are valuable tools in technical analysis, offering traders insights into potential trend reversals. While these patterns are reliable, they should be used in conjunction with other technical indicators to confirm the trend change. By understanding the psychology behind these patterns, traders can better position themselves to take advantage of shifts in market sentiment.

Three Inside Up & Three Inside Down Pattern

What Is Three Inside Up/Down?

The terms “three inside up” and ” inside down” refer to a pair of candle reversal patterns (each containing three individual candles) that appear on candlestick charts. The pattern requires three candles to form in a specific sequence, showing that the current trend has lost momentum and a move in the other direction might be starting.

Key Characteristics of Three Inside Up/Down

Three Inside Up:

The three inside up pattern is a bullish reversal pattern composed of a large down candle, a smaller up candle contained within the prior candle, and then another up candle that closes above the close of the second candle.

Three Inside Down:

The three inside down pattern is a bearish reversal pattern composed of a large up candle, a smaller down candle contained within the prior candle, and then another down candle that closes below the close of the second candle.

These patterns are short-term in nature and may not always result in a significant or even minor trend change. Consider using these patterns within the context of an overall trend. For example, use the three inside up during a pullback in an overall uptrend.

Understanding the Three Inside Up/Down Candlestick Patterns

Three Inside Up:

The market is in a downtrend or a move lower.
The first candle is a black (down) candle with a large real body.
The second candle is a white (up) candle with a small real body that opens and closes within the real body of the first candle.
The third candle is a white (up) candle that closes above the close of the second candle.

Three Inside Down:

The market is in an uptrend or a move higher.
The first candle is a white candle with a large real body.
The second candle is a black candle with a small real body that opens and closes within the real body of the first candle.
The third candle is a black candle that closes below the close of the second candle.

The three inside patterns are essentially harami patterns that are followed by a final confirmation candle, which many traders wait for with the harami anyway.

Three Inside & Trader Psychology

Three Inside Up: The downtrend continues on the first candle with a large sell-off posting new lows. This discourages buyers, while sellers grow confident.

The second candle opens within the prior candle’s trading range. Rather than following through to the downside, it closes higher than the prior close and the current open. This price action raises a red flag, which some short-term short sellers may use as an opportunity to exit.

The third candle completes a bullish reversal, trapping remaining short-sellers and attracting those who are interested in establishing a long position.

Three Inside Down: The uptrend continues on the first candle, with a large rally posting new highs. The second candle opens within the prior candle’s trading range and closes below the prior close and current open. This causes concern for the buyers, who may start selling their long positions.

The third candle completes a bearish reversal, where more long positions are forced to consider selling and short-sellers may jump in to take advantage of the falling price.

Trading the Three Inside Up/Down Candlestick Pattern

The three inside up/down pattern doesn’t need to be traded. It can simply be used as an alert that the short-term price direction may be changing.

For those that do wish to trade it, a long position can be entered near the end of the day on the third candle, or on the following open for a bullish three inside up. A stop loss can be placed below the low of the third, second, or first candle. This depends on how much risk the trader is willing to take on.

For a bearish three inside down, a trader could enter short near the end of the day on the third candle, or at the open the following day. A stop loss can be placed above the third, second, or first candle high.

These patterns do not have profit targets. Therefore, it’s best to utilize another method for deciding when to take profits, should they develop. This could include using a trailing stop loss, exiting at a predetermined risk/reward ratio, or using technical indicators or other candlestick patterns to signal an exit.

These patterns can appear quite often and will not always signify that the price is set to trend in a new direction. The pattern is fairly common, and therefore not always reliable. The pattern is also short-term in nature, so while it may occasionally result in significant trend changes, it may bring about only a small to medium-sized move in the new direction. Following the pattern, the price may not follow through in the direction expected at all, and may instead reverse course once again, in the direction of the original trend.

Trading in the same direction as the long-term trend may help improve the performance of the pattern. Therefore, during an overall uptrend, consider looking for the three inside up during a pullback. This could signal that the pullback is over and the uptrend is resuming.

During a downtrend, look for the three inside down following a small move higher. This could signal the move higher is over and the downtrend is resuming.

Concluding Thoughts

The three inside up/down candlestick patterns provide traders with a potential signal for a reversal in the current trend. However, due to their common occurrence and short-term nature, these patterns should be used with caution and in conjunction with other technical analysis tools. Confirmation is key, and aligning trades with the overall trend can increase the likelihood of success when trading these patterns.