In the example above, the “Black” line is the ADX Signal line, while the “Green” line represents ascending directional movement and the “Red” line, the descending DM. The values for each of the three lines of the ADX are always absolute. The ADX does not necessarily indicate that a reversal is imminent. Other oscillators are better suited for this purpose, but it does speak to momentum and directional strength. Read price first, and then read ADX in the context of what price is doing. When any indicator is used, it should add something that price alone cannot easily tell us.
Unlike other trend indicators the ADX is non-directional, meaning it simply register the strength of the trend, not whether it is an up-trend or a down-trend. In order to indicate whether prices are moving higher or lower the ADX Indicator is plotted with the +DMI and –DMI lines from which the ADX is derived. The Moving Average Convergence Divergence indicator is used to determine trend direction, its strength as well as a possible reversal. When the MACD and ADX are combined, the former is best utilised to detect reversals, with the latter qualifying them. A signal to buy will be triggered when the MACD rises above the zero, line with the ADX rising above 20 and the +DI line crossing above –DI line. Similarly, a signal to sell will be triggered when the MACD falls below the zero line, with the ADX rising above 20 and the -DI line crossing above the +DI line.
Once you have become familiar with this ADX trading strategy and are confident with its limitations and its strengths, give it a test in real-time. Look for support from other indicators, and do not fret if false alerts occur. No indicator system is perfect, but the ADX indicator can provide the edge needed to win consistently in the forex market. The rollercoaster of price behaviour after October forms a strong downward trend. The channel formed is a direct divergence from what the ADX signal line is showing, which keeps rising until it hits the 40-level. The advantage for the trader is in knowing that momentum is not subsiding.
Volume Indicator
Conducting a short trade from that point until the final green circle could have yielded a gain of 200 pips. If you had been a nimble trader, you could have gained another 300 pips via trades from points “D” and “E”. If you had used additional indicators, then the opportunity for trades from “A” through “C” could have added another 250 pips to the total. Steps “2” and “3” represent prudent risk and money management principles that should be part of your trading plan. The ADX does not hint at the correct placement of a Stop Loss order. An average is suggested in this example, but you could also have used an ATR indicator to guide your placement.
If you want the trend to be your friend, you’d better not let ADX become a stranger. ADX has some weaknesses that make it unsuitable to be used as a standalone indicator. To start with, it is based on moving averages, which means that it is largely a lagging indicator that reacts slower to price changes in the market. ADX is also practically inefficient when trading less volatile or ranging markets.
ADX fluctuates from 0 to 100, with readings below 20 indicating a weak trend and readings above 50 signaling a strong trend. Technical analysis focuses on market action — specifically, volume and price. Technical analysis is only one approach to analyzing stocks. When considering which stocks to buy or sell, you should use the approach that you’re most comfortable with. BTW – Any information communicated by Stonehill Forex Limited is solely for educational purposes. The information contained within the courses and on the website neither constitutes investment advice nor a general recommendation on investments.
When the resulting two trend lines form opposite trajectories, it indicates a divergence between the ADX momentum and price. Although traders generally rave about the ADX as a trend indicator, it does pose limitations that traders should be aware of. Using the ADX along with the +DI and -DI can help you identify bearish and bullish trends, addressing one of the biggest weaknesses of using the ADX on its own.
When trading, it can be helpful to gauge the strength of a trend, regardless of its direction. Determine significant support and resistance levels with the help of pivot points. Find the approximate amount of currency units to buy or sell so you can control your maximum risk per position.
This line registers a trend’s strength but it doesn’t show its direction. Let’s clean it up by removing two of the lines; the “yellow-green” and “wheat”, which represent the bullish and bearish indicators. We only want to keep the “LightSeaGreen” line, which represents volume. We’ll make those adjustments in the settings screen, on the colors tab.
ADX as a Volume Indicator
VALUTRADES LIMITED is authorized and regulated by the Financial Services Authority of the Seychelles. ADX is simply the mean, or average, of the values of the DX over the specified Period. Below is a screenshot of what the indicator looks like on the daily time frame.
Below, the price moves from a low ADX price channel to an uptrend with strong ADX. The stochastic oscillator and MACD are already a popular pairing because of their complementary roles in analyzing trade opportunities. In forex trading, there’s ample logic behind the rhyme “the trend is your friend.” Trading in the direction of a strong trend both minimizes your risk and increases your potential profit.
Note that we’ve changed the color of the candles to white to remove any emotional bias so that only the indicator is prominent. Place a stop-loss order at 25 “pips” below your entry point. A directional Signal index is computed as an absolute value per cent of the difference between the two DM’s divided by their sum. For the remainder of this article, ADX will be shown separately on the charts for educational purposes. ADX can be used on any trading vehicle such as stocks, mutual funds, exchange-traded funds and futures. From then on, the pair could possibly move sideways, so you might want to lock in those pips before that happens.
Potential Risks of Using the ADX
Welles Wilder Jr., this trend indicator has earned its place as a staple in analytical trading strategies for 40 years. Trend strength, direction, and momentum can also be verified using the moving average convergence divergence . A trader must remember that the ADX signal line is an absolute value, always a positive number measuring the strength of either a positive or negative trend.
When the +DI crosses above the –DI line, it implies that the rate of positive price change in the market is greater than the negative price change. If this happens when the ADX is above 25, it is a solid signal to place buy orders. Similarly, when the -DI crosses above the +DI line, it implies that the rate of negative price change in the market is greater than the positive price change.
Another way is to combine ADX with another indicator, particularly one that identifies whether the pair is headed downwards or upwards. If there’s one problem with using ADX, it’s that it doesn’t exactly tell you whether it’s a buy or a sell. Just like in our first example, ADX hovered below 20 for quite a while.
Reading the ADX Indicator
The ADX can be used to determine the potential for market changes depending on the movement of values, but confirmation from another indicator is advised. If the ADX moves over 25 points from its lower values, attention is given as it approaches the 40 line. The ADX generates trading signals when the two minor DM lines cross one another, with special consideration given to peaks in the Signal line. First, use ADX to determine whether prices are trending or non-trending, and then choose the appropriate trading strategy for the condition. In trending conditions, entries are made on pullbacks and taken in the direction of the trend. In range conditions, trend-trading strategies are not appropriate.
Correctly interpreting the signals of the ADX indicator requires practice on a demo system, and it works best when combined with other indicators. The Average Directional Movement Index or “ADX” indicator is a member of the Trend family of technical indicators. Welles Wilder created the ADX in 1978 to complement his other creative efforts in technical analysis by measuring the strength of trend forces. Traders use the index to determine if a trend will extend or gradually lose its strength; valuable information when setting entry and exit levels in the forex market. A weakness of this oscillator is that many crossovers can be false signals if the currency pair moves in a sideways fashion. Strength does not always equate to a positive or negative movement in prices.
Like the non-lag MACD, crossing above or below the “zero line” provides our signal. Used in conjunction with baseline and entry indicators, the confluence of indicators increases your odds of a successful trade. In summary, the ADX did not rise past 25 until the third green circle.