Directional Movement v. Weinstein

An often-discussed system for tracking trends is the Directional Movement System set for weekly, rather than daily, directional movement. We compare performance to Stan Weinstein's breakout model, which combines a 30-week weighted moving average with trendlines and support/resistance.

Time Frames

Normal settings are 11-week Directional Movement. This is sometimes combined with Parabolic SAR to act as an additional filter. I have opted for a simpler system, entering on the next pull-back after the DI/ADX signal.

Trading Signals

DMS makes frequent whipsaws when not in a strong trend; so it is important to have an additional filter. My preference is Alexander Elder's system, where ADX must be rising before the signal is taken:

Go long when +DI is above -DI and either:

ADX rises while +DI and ADX are above -DI; or
ADX turns up from below +DI and -DI.

Exit when +DI crosses below -DI.

Go short when -DI is above +DI and either:

ADX rises while -DI and ADX are above +DI; or
ADX turns up from below +DI and -DI.

Exit when -DI crosses below +DI.

Further fine-tuning:

Enter on the first pull-back (on the DI line) after the above signal;
Exit if ADX turns down when above 50.

Example 1

Entry and exit signals from Stan Weinstein's breakout model ("SW") are plotted on the ASX All Ordinaries price chart below: [L] for long entries; [S] for short entries; and [X] for exits.

[L] is a poor entry: a pull-back respects the new support level after the breakout (and above 30-week WMA) but later is stopped out at [X].
The index respects resistance from the breakout and 30-week WMA at [S]. The exit point is debatable with such a sharp downward spike.
[L] is just as late as the index rebounds in late 2001.
Another good entry signal at [S2] when the pull-back respects resistance from the breakout and the 30-week WMA. The exit is slightly late at [L2].
The long entry [L2] is taken when the index respects the WMA after breaking the downward trendline (not shown). This is a strong up-trend and the 30-week WMA keeps you in until the downward breakout at [X].

Compare the results to the 11-week Directional Movement System below the price chart.

XAO with Directional Movement System

The filters help to avoid most of the whipsaws evident in 2000/2001 and again in mid-2002 and mid-2003.
Signals on the DMS indicator:

[L] is earlier than SW but possibly more risky as it occurs prior to breakout.
The exit point is similar (to SW).
The entry for [S] is identical: the first pull-back that respects the resistance line. The DMS exit is way too late; the index is already back at 3200.
Entry for [S2] at 3200 is also a lot later than SW (when price forms a double top below the resistance line at 3350).
Exit points are similar.
The long entry [L2] is again later than SW (when price forms a double-bottom above the 30-week WMA), though the exit comes up trumps as ADX turns down while above 50 right at the trend peak.

If we had to use the ADX filter (ADX > 25), the signals appear even later:

ALL ORDS with ADX

[S1] is at the bottom of the sharp downward spike in 2001.
[S2] is close to the dip below 3000.
[L] is even slower than the highly reliable Coppock indicator.

Example 2

Entry and exit signals from Stan Weinstein's breakout model ("SW") are plotted on the Harvey Norman [HVN_AX] price chart below:

[S1] is the first pull-back that respects both resistance at 4.00 and the 30-week WMA. Additional condfirmation is provided by the trendline.
[S2] is a second entry point, respecting resistance at 3.20, the trendline and 30-week WMA.
The exit occurs when price breaks the second trendline at [L].
Go long at [L] when the second pull-back respects the 30-week WMA after breaking the downward trendlline.
The stock enters an accelerating (blow-off) up-trend exposing an SW weakness: the exit [X] is late, almost 20% below the high.
Price then forms a base before a long entry at [L2], possibly with a whipsaw just before. The exit is before [S3] when price falls below the WMA.
Lastly [S3] provides a good short opportunity, with a pull-back that respects the trendline and 30-week WMA. The exit [X] is when HVN breaks the downward trendline.

HVN with Directional Movement System

Signals on the DMS indicator:

[S] provides a poor entry point at the bottom of a correction.
Further poor entries at [3] and [4] are avoided as there was no pull-back on which to enter.
[S2] is signaled at the start of a consolidation pattern. Stopped out by the short spike at [X].
[S3] provides a better signal, on the pull-back after a downward breakout. The exit is similar to SW.
The long entry [L] is again late but the exit signal comes up trumps: ADX turns down while above 50, straight after price has peaked.
[L2] is a good early signal while the exit is similar to SW.
[S4] is late.

Conclusion

Late Directional Movement signals are not compensated by increased reliability.

The one aspect of the DM system that I was impressed with was the ADX down-turn from above 50. It provides early signals for the expiry of strong trends, with roughly a 2:1 success rate when the signal occurs. Most of the misfires take you out of the trend too early; so it could be used as a signal to move your stops up to below each consecutive swing low (similar to how Stan Weinstein alters his stop-loss rules when the MA flattens out).

That may be a useful addition to Stan Weinstein's breakout model which is often exposed by late exits from blow-off trends. Despite this flaw, I have yet to find a better trend following system.

	Directional Movement v. Weinstein An often-discussed system for tracking trends is the Directional Movement System set for weekly, rather than daily, directional movement. We compare performance to Stan Weinstein's breakout model, which combines a 30-week weighted moving average with trendlines and support/resistance. Time Frames Normal settings are 11-week Directional Movement. This is sometimes combined with Parabolic SAR to act as an additional filter. I have opted for a simpler system, entering on the next pull-back after the DI/ADX signal. Trading Signals DMS makes frequent whipsaws when not in a strong trend; so it is important to have an additional filter. My preference is Alexander Elder's system, where ADX must be rising before the signal is taken: Go long when +DI is above -DI and either: ADX rises while +DI and ADX are above -DI; or ADX turns up from below +DI and -DI. Exit when +DI crosses below -DI. Go short when -DI is above +DI and either: ADX rises while -DI and ADX are above +DI; or ADX turns up from below +DI and -DI. Exit when -DI crosses below +DI. Further fine-tuning: Enter on the first pull-back (on the DI line) after the above signal; Exit if ADX turns down when above 50. Example 1 Entry and exit signals from Stan Weinstein's breakout model ("SW") are plotted on the ASX All Ordinaries price chart below: [L] for long entries; [S] for short entries; and [X] for exits. [L] is a poor entry: a pull-back respects the new support level after the breakout (and above 30-week WMA) but later is stopped out at [X]. The index respects resistance from the breakout and 30-week WMA at [S]. The exit point is debatable with such a sharp downward spike. [L] is just as late as the index rebounds in late 2001. Another good entry signal at [S2] when the pull-back respects resistance from the breakout and the 30-week WMA. The exit is slightly late at [L2]. The long entry [L2] is taken when the index respects the WMA after breaking the downward trendline (not shown). This is a strong up-trend and the 30-week WMA keeps you in until the downward breakout at [X]. Compare the results to the 11-week Directional Movement System below the price chart. The filters help to avoid most of the whipsaws evident in 2000/2001 and again in mid-2002 and mid-2003. Signals on the DMS indicator: [L] is earlier than SW but possibly more risky as it occurs prior to breakout. The exit point is similar (to SW). The entry for [S] is identical: the first pull-back that respects the resistance line. The DMS exit is way too late; the index is already back at 3200. Entry for [S2] at 3200 is also a lot later than SW (when price forms a double top below the resistance line at 3350). Exit points are similar. The long entry [L2] is again later than SW (when price forms a double-bottom above the 30-week WMA), though the exit comes up trumps as ADX turns down while above 50 right at the trend peak. If we had to use the ADX filter (ADX > 25), the signals appear even later: [S1] is at the bottom of the sharp downward spike in 2001. [S2] is close to the dip below 3000. [L] is even slower than the highly reliable Coppock indicator. Example 2 Entry and exit signals from Stan Weinstein's breakout model ("SW") are plotted on the Harvey Norman [HVN_AX] price chart below: [S1] is the first pull-back that respects both resistance at 4.00 and the 30-week WMA. Additional condfirmation is provided by the trendline. [S2] is a second entry point, respecting resistance at 3.20, the trendline and 30-week WMA. The exit occurs when price breaks the second trendline at [L]. Go long at [L] when the second pull-back respects the 30-week WMA after breaking the downward trendlline. The stock enters an accelerating (blow-off) up-trend exposing an SW weakness: the exit [X] is late, almost 20% below the high. Price then forms a base before a long entry at [L2], possibly with a whipsaw just before. The exit is before [S3] when price falls below the WMA. Lastly [S3] provides a good short opportunity, with a pull-back that respects the trendline and 30-week WMA. The exit [X] is when HVN breaks the downward trendline. Signals on the DMS indicator: [S] provides a poor entry point at the bottom of a correction. Further poor entries at [3] and [4] are avoided as there was no pull-back on which to enter. [S2] is signaled at the start of a consolidation pattern. Stopped out by the short spike at [X]. [S3] provides a better signal, on the pull-back after a downward breakout. The exit is similar to SW. The long entry [L] is again late but the exit signal comes up trumps: ADX turns down while above 50, straight after price has peaked. [L2] is a good early signal while the exit is similar to SW. [S4] is late. Conclusion Late Directional Movement signals are not compensated by increased reliability. The one aspect of the DM system that I was impressed with was the ADX down-turn from above 50. It provides early signals for the expiry of strong trends, with roughly a 2:1 success rate when the signal occurs. Most of the misfires take you out of the trend too early; so it could be used as a signal to move your stops up to below each consecutive swing low (similar to how Stan Weinstein alters his stop-loss rules when the MA flattens out). That may be a useful addition to Stan Weinstein's breakout model which is often exposed by late exits from blow-off trends. Despite this flaw, I have yet to find a better trend following system. Author: Colin Twiggs is a former investment banker with over 30 years experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary newsletter. Colin also writes The Patient Investor newsletter which focuses on the global economic outlook and key macro trends. In addition, he founded PVT Capital (AFSL No. 546090) which offers investment strategy and advice to wholesale clients.	Share: Incredible Charts 11.0 Proprietary trading tools and stock screens now in your browser. Free Trial 30-Day Free Trial Try it Now! Trading Diary Free education, macro outlook and technical updates: Join Now A+ A−
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