Using the ADX Indicator for Forex Trading: A How To Guide

November 17, 2021 3:34 pm Published by

ADX indicator can also be effectively used for risk management. Traders can use the falling ADX line as an indicator of a weakening trend. Traders can therefore exit their trading positions or reduce their position size to avoid potential losses. Keep in mind, if ADX is below 20, it might not be the most ideal time to enter a trade. The Average Directional Index projects market price and it is clearly seen when prices move up (when +DI is above -DI), and when the prices move down (when -DI is above +DI). When there are crosses between both +DI and -DI lines, it can signify potential trading signals, as a bearish or bullish market emerges.

Some stocks have price characteristics similar to commodities, which tend to be more volatile with short and strong trends. Stocks with low volatility may not generate signals based on Wilder’s parameters. Chartists will likely need to adjust the indicator settings or the signal parameters according to the characteristics of the security. 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.

When day trading with the ADX indicator, we look for clues to buy and sell when ADX falls below 25. Going forward, keep in mind that the ADX indicator doesn’t give you any information about the direction of the market. It just provides you with information about the strength of a trend. It is fair to say that the ADX isn’t the simplest of indicators, which is why traders often make a few crucial mistakes when applying it. When ranging, the trend is moving sideways, and the market is kind of calm, without the significant prevalence of either buyers or sellers. Should the supply/demand ratio change, however, the market will react by breaking the range.

Reading the Average Directional Index (ADX)

While ADX can be plotted above, below or behind the main price plot, it is recommended to plot above or below because there are three lines involved. The chart example below also shows the 50-day SMA and Parabolic SAR plotted behind the price plot. Only buy signals are used when trading above continuation patterns the 50-day moving average. The ADX is a hybrid of Wilder’s positive directional indicator (+DI) and negative directional indicator (-DI), with the addition of a simple moving average. Although the +DI and -DI are both indicative of trend direction, the ADX reveals trend strength alone.

When the trend is strong, trading with the trend has the greatest profit potential. Trend strength, direction, and momentum can also be verified using the moving average convergence divergence (MACD). ADX calculations are based on a moving average of price range expansion over a given period of time. The default setting is 14 bars, although other time periods can be used. ADX can be used on any trading vehicle such as stocks, mutual funds, exchange-traded funds and futures.

The indicator has repeatedly proven that it is the most effective when applied during clearly established trends and not during sideways markets. A crossover between the +DI and the –DI is also a useful signal. When the +DI line crosses above the –DI one and the ADX ranges above 25, this is considered a buy signal.

Common Mistakes When Using the ADX

When the DI- line crosses above the DI+ line, traders could place a short position with a stop above the high of the current day, or above a recent swing high. Traders could use a trailing stop if the trade moves in their favor to help lock in profits. Since ADX is non-directional, this shows the reversal is as strong as the prior trend.

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For starters, the ADX provides traders with more precise entry and exit points. When the ADX moves above 25 and continues to rise, many traders view it as an invitation to enter a trade. Plotting all three indicators together allows traders to simultaneously gauge trend direction and strength. When the +DI is above the -DI, it indicates that the price is in an uptrend. In contrast, when the -DI is above the +DI, the price is in a downtrend.

Strength of Trend

As with an exponential moving average, the calculation has to start somewhere so the first value is simply the sum of the first 14 periods. As shown below, smoothing starts with the second 14-period calculation and continues throughout. When the ADX is low, it highlights periods ‎axicorp financial services pty ltd apps on the app store when the price is usually going sideways or trading in a range. Adx indicator on alone does not signify whether the trend is Uptrend or Trend is Downtrend. When using the ADX as a momentum indicator, trace a trend line along the ADX peaks and another one along your price peaks.

Traders may find readings other than 25 are better suited to indicate a strong trend in certain markets. Wilder instructed readings above 25 are trending markets and readings below 20 are choppy or sideways markets. This scan starts with stocks that average 100,000 shares daily volume and have an average closing price above 10. The what is enterprise software and its types Average Directional Index (ADX) is used to measure the strength or weakness of a trend, not the actual direction. In general, the bulls have the edge when +DI is greater than -DI, while the bears have the edge when -DI is greater. Crosses of these directional indicators can be combined with ADX for a complete trading system.

Like any indicator, the ADX should be combined with price analysis and potentially other indicators to help filter signals and control risk. The least square moving average (LSMA) calculates the least squares regression line for the preceding time periods, thus leading to forward projections from the current period. But instead of trending, the stock enters a sideways trading pattern, which would have you wasting time and money. The chart above shows AT&T (T) with three signals over a 12-month period. These three signals were pretty good, provided profits were taken and trailing stops were used. Wilder’s Parabolic SAR could have been used to set a trailing stop-loss.

An ADX reading back below 25 suggests the prevailing trend is running out of strength. To accomplish this we take profits as soon as the ADX indicator breaks back below 25. So, we want to sell when the RSI indicator breaks and shows a reading below 30. The RSI uses a 20-period setting, which is the same as the ADX indicator settings. Here, we like the Holy Grail strategy, which is based on the ADX indicator and the 20-period EMA. Low ADX readings (consolidation) should be followed by higher ADX readings (trend).

It may be appropriate to tighten the stop-loss or take partial profits. The direction of the ADX line is important for reading trend strength. When the ADX line is rising, trend strength is increasing, and the price moves in the direction of the trend. When the line is falling, trend strength is decreasing, and the price enters a period of retracement or consolidation. Looking at the image above, we can see the -DI (red line) above the +DI (green line) at the beginning. Conversely, when the +DI is above the -DI, this is indicative of a bullish (upward) trend.

The ADX Indicator is a component of the Directional Movement System developed by Welles Wilder. The stochastic oscillator and MACD are already a popular pairing because of their complementary roles in analyzing trade opportunities. The ADX also lacks clear guidance in terms of signals to use when exiting a position.

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