ADX: Find the Strong Trend

In a wide variety of indicators that provide different signals, it's almost impossible to find the one that defines the trend's strength. It's vital to know whether the trend is stable or not, especially during peak timeframes, when it exists from several days to several months. What if you see a trend and want to open a position but have no idea how soon it'll end? Wilder invented the ADX indicator specifically for cases like those.

What Is the ADX Indicator?

ADX stands for Average Directional Index. It's a technical indicator that is mainly used to determine the trend's strength. At the same time, it can be applied to find trends and ranges and filter trading strategies. Usually, the indicator consists of a single line that fluctuates within the 0-100 range.

However, sometimes you can see the indicator of three lines: ADX, +ID and -ID. Two additional lines are a positive directional indicator and a negative directional indicator. These serve to provide the trend's direction, and the average directional index is derived from them. 

The indicator was invented by the technical trader J. Welles Wilder, who described the average directional index together with the minus directional indicator (-DI) and the plus directional indicator (+DI) in his book New Concepts in Technical Trading Systems in 1978.

This index has been around for many years, proving that ADX can stand the test of time and provide valuable information. Have a look at the picture.

The indicator of three lines: ADX, +ID and -ID

Why ADX Is So Popular

The ADX indicator is almost the only existing indicator that shows a trend's strength. Even though other indicators also provide signals that show close reversal or possible breakouts, the average directional movement index gives more accurate signals. Additionally, you can use this indicator to work in the forex market and to trade stocks, futures and even mutual funds.

ADX Calculation

The calculation may seem a little complicated, but you don't have to do it every time you use it because the calculation is done automatically. The ADX formula will just help you understand how the indicator works.

The calculation starts with measuring positive and negative directional movement. 

  • +DM = Current High - Previous High
  • -DM = Previous Low - Current Low

There's an exciting feature here. If +DM is bigger than -DM, then -DM equals 0. If -DM is greater than +DM, +DM is 0. As we mentioned earlier, the index is derived from +DI and -DI. The positive directional indicator (+DI) amounts to 100 times the exponential moving average (EMA) of +DM divided by the ATR (average true range) over a given period of time.

The standard period is 14. The negative directional indicator (-DI) equals 100 times the EMA of -DM divided by ATR. As for the average directional index, it's equal to 100 times the EMA of the absolute value of (+DI minus -DI) divided by (+DI plus -DI).

Strong Signals From ADX

There's a common misconception that the indicator shows the trend direction. The indicator shows only the strength of that trend. If you want to get the direction, you need to use ADX together with the -DI and +DI. There's a drawback of ADX not always being accompanied by these two lines depending on the trading platform you use. We'll tell you both about the single ADX and ADX with two directional movement indicator lines to provide you with full information.

Basic Levels

If the indicator is below 25, the market is moving sideways. If the index is above 25, the market is forming a new trend, and the strength depends on the levels the indicator crosses.

ADX Value

Trend Strength

0-25 

Absent or Weak Trend

25-50

Strong Trend

50-75

Very Strong Trend

75-100

Extremely Strong Trend

Trend Momentum

ADX reflects the trend's momentum. If the indicator forms a series of higher highs, the trend is gaining momentum (i.e., becoming stronger). If ADX forms a series of lower peaks, the trend momentum is shortening. However, if the peaks become smaller but the indicator remains above 25, that doesn't mean the trend is changing. It just means it's losing momentum.

Why do you need this information? When you know the trend's momentum is rising, you get more confidence in keeping your position. At the same time, when you see the indicator signals the weakness of the momentum, but the trend still interacts, it's a sign that you should manage risk.

This is where we can apply another strategy. If the indicator forms a divergence from the price chart, you should consider managing your risks. When the price creates a higher high, but the index doesn't follow it and instead forms a lower high, this is divergence. If you've heard something about RSI or MACD indicators, you know that divergence usually signals a market reversal. In this case, the signal isn't that strong. The index indicates that the trend is weakening. However, the weakness may end up in consolidation, a reversal or a continuation of the trend.

Breakouts

Breakouts happen in the market very often. It's common if the breakout fails to develop and becomes a trap for traders. It's essential to have an indicator that will either confirm or disprove them. The rule is simple: if the index rises in the range from 0 to 25, the price is strong enough to keep moving towards the breakout direction. 

Ranges

It's vital to know when the trend transforms into the range. To find that out, follow the ADX. When the ADX falls from above 25 to below 25, it indicates a range. There's no trend until the index is in the bottom zone. As soon as it rises, the price starts moving according to the trend.

ADX and Two Directional-Movement Indicator Lines

As we stated above, the indicator is often followed by two lines that help define the trend's course. The signals are fairly simple.

  • When +DI is higher than -DI, it's a bullish trend.
  • If -DI is greater than +DI, the trend is bearish.
  • Buy when +DI breaks above -DI. The ADX should be above 25.
  • Sell when -DI rises above +DI. The ADX should be above 25.

How to Use ADX

The ADX is one of the fundamental indicators that's usually implemented into any trading platform. The only difference is that some platforms, for example, MetaTrader, provide the indicator with three lines while others have only one line.

To apply the indicator to the chart, you need to find it in the indicators list. In the settings, 14 is the standard number for the period. However, you can apply another one based on your trading strategy.

Common Mistakes with ADX

The indicator measures the trend's strength, not its direction, as many other indicators do. This is the most common mistake of a beginner trader. When you look at the index, you may associate it with the stochastic oscillator because it looks similar. The key levels are used to show how strong the trend is, not whether it's bearish or bullish.

Another mistake is reading the signal incorrectly. Newbies think that when the indicator drops, it means the trend is reversing. In fact, it only indicates that the trend is weakening. Until the indicator crosses 25, think of the trend as being weaker.

Every trader is eager to catch the signal to enter the market at the perfect level. However, not every sign is correct. Using the full system with ADX and directional indicator lines makes it easy to get confused. +DI and -DI are frequently intertwined, resulting in traders getting false signals. To avoid this, you need to compare signals provided by different indicators or candlesticks.

The Best ADX Trading Strategy

It's up to you to find the perfect settings for the indicator and include them in your trading strategy. However, we'd like to share the one method that can help you get some money.

Step 1.

Choose an asset you'd like to trade and any timeframe that you're more familiar with. Apply the ADX and RSI indicators with standard settings to the chart. Before we determine whether the trend is bearish or bullish, we need the average directional index to be above 25. As you might already know, this signals a strong trend.

ADX is above 25 level

Step 2.

Looking at the last 10 candlesticks is enough to identify the trend. If the price is moving lower in the previous 10 candlesticks, it's a bearish trend. If it's moving up, it's a bullish trend. However, the number of candlesticks depends on the timeframe. The larger the timeframe is, the more candlesticks there should be.

ADX: Downtrend

Step 3

Follow the RSI indicator and trade within the downtrend. Wait for the RSI indicator to cross 30. As soon as the index drops below 30, open a sell position. If you've heard about the RSI indicator, you can be a little bit confused. According to the standard rules, readings below 30 signify an upcoming reversal as the market is oversold. However, it's essential to use the indicators correctly.

The RSI indicator can fluctuate in either oversold or overbought zone for an extended period in the strong trend. So, we need the ADX to signal a strong trend. 

RSI falling below 30 level

Step 4

It's time to define a stop-loss level that will neither throw you out of the market nor allow you to lose a lot. To find the perfect stop-loss level, you need to find where the ADX formed the last high before your entry. Correspond this high to the price chart, and you'll get the stop-loss level.

ADX: Stop loss

Step 5

In the beginning, we were looking for a strong trend. It's the most crucial part of our strategy. That's why we'll take the profit based on the trend strength. As soon as the trend fades, we should be ready to close the trade. Wait for the ADX to cross the 25 downward and close your position. 

ADX: Take profit

The strategy can easily be used in a bullish trend. All you need to do is use each step in the inverse.

FAQ

We've covered what the ADX is, but we'll review some of the most frequently asked questions once more.

Which Indicator Works Best With ADX?

The first indicator is the RSI. You shouldn't be surprised that one of the best trading strategies combines ADX and RSI signals. Although the RSI indicator is an oscillator and the ADX is a trend indicator, they work well together. Every trader knows that it's easier to trade with a trend, not with a sideways market. As such, the RSI may provide reliable entry points, while the ADX can give signals on the trend's power.

You can also use the index with other trend indicators, such as Parabolic SAR. It's worth choosing indicators that aren't based on Moving Averages. As a reminder, the ADX calculation includes the Exponential Moving Average.

Is the ADX a Leading or Lagging Indicator?

The average directional index is based on the exponential moving average. All moving averages lag in time. So, the ADX is a lagging indicator, but that's the only limitation it has. The ADX confirms a trend only after it's formed; it's impossible to predict the strength of something that doesn't yet exist.

Conclusion

The ADX indicator can be considered exceptional. It's almost the only indicator that provides a trader with information on trend strength. Remember: the trend is your friend. However, it's not as easy to find a strong trend. As a result, you might lose money during breakouts and fakeouts, trend reversals and market consolidation. To determine the indicator faster, check its signal with a risk-free Libertex demo account that lets you trade with simulated funds in an environment that mirrors real-world trading conditions.

Source   Presented by LibertexForex Columns
Not a fossilised relic just yet

With the buzz around renewable energy and EVs following the announcement of Biden's Green New Deal, oil and other traditional fossil fuels fell out of favour with investors - and this despite record low prices. Brent was trading at a more than twenty-year...

Bitcoin ETF Approval Unleashes The Crypto Bull

In the growth and development of Bitcoin towards a mainstream financial asset, the desire to have a Bitcoin ETF has been high on the wish list. Many companies have put forward proposals only for the SEC to strike them down over fears of market...

Netflix's "Squid Game" Leads Company to Leadership

The series "Squid Game" gathered 111 million viewers in 17 days and became the most popular project for the company. Well, in this game, Netflix is ahead of its competitors. Netflix shares are in an upward...


Do IBs have a regular broker access?

When choosing to be a part of something, we usually consider the reasons that would make us want to join. Maybe it's the people involved, or trustworthiness or even potential advantages and status. However, there...

Everything you Wanted to Know about Dogecoin

Sometimes, the best things in life start as a joke, and Dogecoin is not an exception. Initially created as a joke in December 2013, based on the popular Doge meme of a Shiba Inu dog, it soon became a popular cryptocurrency...

Can you make money with crypto arbitrage?

Crypto arbitrage is the practice of and methodology behind taking advantage of price fluctuations in the price of various cryptocurrencies, such as Bitcoin or Ethereum. These variances in price can be insignificant at times...

Top 10 Forex Awards Nominations 2021

All Forex Awards Nominations

Top Forex Nominees 2021

We are evaluating and honoring the best forex brokers in almost 30 nominations

FxPro Detailed review and information

FxPro is an award-winning online broker offering Contracts for Difference (CFDs) and Spread Betting on forex, futures, spot indices, shares, spot metals and spot energies. FxPro serves clients in...

NordFX Detailed review and information

NordFX is a leading multi-awarded international broker that offers individuals and companies a full set of services for Forex trading. Since its foundation in 2008, NordFX always keeps abreast of...

OctaFX Detailed review and information

Octa Markets Incorporated is a forex broker recognized worldwide. OctaFX provides forex brokerage services to its clients in over 100 countries around the world. OctaFX uses the most up-to-date...

Previous Years Forex Awards Announced Winners

We are evaluating the best achievements in the foreign exchange industry since 2010

© 2010-2020 Forex-Awards.com


The usage of this website constitutes acceptance of the following legal information, Terms, Conditions, Cookies policies.
Any contracts of financial instruments offered to conclude bear high risks and may result in the full loss of the deposited funds. Prior to making transactions one should get acquainted with the risks to which they relate. All the information featured on the website, including graphical information about the forex companies, brokers and others, is intended solely for informational purposes, is not a means of advertising them, and doesn't imply direct instructions for investing. Forex Awards shall not be liable for any loss, including unlimited loss of funds, which may arise directly or indirectly from the usage of this information. The editorial staff of the website does not bear any responsibility whatsoever for the content of the press releases or reviews made by the site contributors about the forex companies. The entire responsibility for the contents rests with the contributors and commentators. Reprint of the materials is available only with the permission of the editorial staff.