04 June 2020 | AtoZ Markets – ADX is a very popular indicator for measuring trend strength. J. Wells Wilder developed the indicator. Moreover, he also developed other very popular technical indicators such as RSI, ATR, parabolic SAR indicators, etc. Traders can use ADX indicator to almost all trading assets, including stocks, forex, mutual funds, and futures contracts. This article will help you to understand how ADX indicator works.
What is the ADX Indicator?
ADX (Average Directional Movement Index) indicator helps to determine the overall trend strength. The indicator calculations are based on an average of expanding price range values. This indicator provides the following important information:
- Notify traders when the market is in trend.
- Filters anti-trend trades.
The ADX is a three-line indicator. Each line measures the price action slightly different than others. By using the following three lines together, traders can determine both the trend direction and strength.
- Positive Directional Index (DI +) shows the strength of positive price movements. When it moves upwards, it indicates that the uptrend is strengthening.
- Negative directional index (DI-) indicates the strength of the positive price movement. A downward movement indicates a weakening downtrend.
- ADX line is the average of the absolute values of the difference between DI+ and DI-, which indicates only the strength of the trend.
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ADX Indicator Calculations
The indicator uses a smoothing moving average in its calculation:
- DI+ = 100 times the moving average of (DM+) divided by true average range
- DI- = 100 times the moving average of (DM-) divided by true average range
- ADX = 100 times the moving average of the absolute value of (+DI − -DI) divided by (+DI + -DI)
Where, DM+ = today's high − yesterday's high
DM- = yesterday's low − today's low
Measuring Trend Strength
The ADX value range is between 0 and 100. The higher value signals a stronger trend. The lower value signals a weaker trend. ADX directional system can also show the changes in market sentiment by tracking changes within the price range.
- When ADX value is between 0-25, it signals a weak trend or non-trending.
- If the ADX value is between 25-50, it is considered to be a strong trend.
- When ADX value is between 50-75, it is considered to be a very strong trend.
- If the ADX value is between 75-100, it is considered to be a powerful trend.
Traders can determine a trend or non-trending market by simply looking at ADX value. During ADX value range between 0 and 25, traders should avoid trend-following strategies.
If the ADX line is declining from high value, it means the trend may be weakening. After staying low for a long time, If the ADX line from 15 to 20, it may signal the beginning of a new trend. If ADX is rising, it means the trend is also strengthening. Moreover, DI+ and DI- line crossover signals a trend reversal.
- If DI+ is above DI-, it is considered as an uptrend.
- When DI+ crossover DI-, it signals the trend may be reversing to bullish.
- If the price and ADX line are rising, it signals bullish trends.
- If DI- is above DI+, it is considered as a downtrend.
- If DI- crossover DI+, it signals the trend may be reversing to bearish.
- When the price is falling, and the ADX line is rising, it signals bearish trends.
Best ADX Trading Strategy
Traders should use following ADX trading strategy on an hourly or daily chart only during a strong trend. Traders often only use the ADX line instead of all three. So, in this trading strategy, we only use the ADX line.
First, traders have to wait for ADX line to cross 25 readings. When ADX value is between 25-50, it is considered to be a strong trend. But a new trend could be fade away, so traders have to look last 50 candles to determine the trend. If the price is going up or down in the previous 50 candles, it's a bullish or bearish trend.
To enter the market, traders have to use an RSI indicator. The Relative Strength Index (RSI) is one of the most popular indicators that can help traders to determine overbought and oversold market condition. In this trading strategy, when RSI show reading 70 or above, it gives buy signal during the bullish trend. On the other hand, when RSI show reading 30 or below, it gives sell signal during the bullish trend. Now, the traders can have their entry point. Then traders have to place a stop-loss order to minimize risk.
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First, traders have to find the last ADX high before the entry point. Second, find the corresponding highs on the price chart. That will a perfect place to put SL. When the strong trend fades, traders should make a profit and wait for another trading opportunity. When the ADX line return to below 25, traders can close the trade and take the profit. ADX value between 0-25, signals a weak trend or non-trending.
ADX is one of the most frequently used and reliable indicators to get a good idea of the ranging markets. Using the indicator, traders can take advantage of the trend strength and make a quick profit. Ultimately, the best profits come from catching strong trends, and the best ADX strategies will help traders reach their trading goals.
Should you use the ADX indicator on your own at all?
Before you start trading with this ADX indicator, you'll want to read this.
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