Welles Wilder is a name well-known to technical analysts for creating a host of indicators such as the RSI, DMI, and others, and Ken Calhoun of TradeMastery.com and DaytradingUniversity.com discusses another one of Wilder's indicators for generating entry and exit signals.
In this second article, we'll look at how to combine wide-range candles as shown in the prior article with a new strategy-that of using Wilder's ADX (average directional index), for momentum stock entry signals. As markets start to show signs of fatigue following a strong rally, it's especially important to be on the lookout for both continuation, as well as exhaustion signals in the charts, to start scaling out of open swing trades, as well as initiate new positions if markets continue upwards.
Using Wide-Range Candles With the S&P: How It Worked During This Rally
In our first article, we looked at how to use "wide range" candles; specifically the pattern as shown in Figure 1 (S&P 500 Index) in which a wide-range candle day was seen after a series of narrow candles. This generated a "buy the markets" signal once it broke over 1530 resistance. It's important when using this technique to make sure to wait for new highs to be taken out above the wide-range candle day prior to entering, to avoid a false breakout.
When used with indexes, it's wise to use a 10-point "false breakout" filter, in this case that would be to wait for highs above 1540 before entering. For stocks and ETFs, it's good to use a .35-cent false breakout filter (for example if the prior day's wide-range candle had a high of $44.0 even, the long breakout signal would be at $44.35).
Once in a trade, in addition to standard reversal candle patterns to watch for (such as shooting stars and bearish engulfing patterns), it's also important to watch for narrow-range candles following a rally. We currently see this in the S&P Figure 1 chart, by the way, as the most recent candles have narrow candle bodies, indicating less strength, and that the markets may pull back or sell down soon (in this case, we'd close open long trades in stocks/ETFs once the S&P loses 1550 support, which may well occur soon).
Also looking back at the Figure 1 chart, you can see the wide-range candle back in early January, on which then was followed by a multi-week long rally. Spotting these alternating wide-vs.-narrow daily candle patterns can be of tremendous value in helping astute active swing and day traders spot upcoming volatility for momentum stock entry signals as they're happening in the markets.
NEXT PAGE: Using ADX for Entries and Exits
Tickers Mentioned: WFC