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ADX Indicator

How to trade the ADX Indicator like a pro !

ADX Indicator

ADX Indicator is one of the most used technical indicators by traders because of its credibility and the role it plays in traders’ strategy and analysis. The reason why ADX is popular is that this indicator is particularly effective for trend tracking.

 

ADX Indicator

 

What is ADX Indicator?

ADX stands for Average Directional Index. The ADX Indicator is a trend strength indicator because it shows how strongly a trend is developing. It does not directly provide buy or sell signals. It therefore represents the strength of a movement, but not the direction. It develops its full competence in interaction with other indicators. Recognizing market trends is its strength, which has a lasting effect on the choice of further analysis tools.

The ADX value lies between 0 and 100.

The higher the displayed value, the stronger the trend development. The lower the ADX value, the weaker the trend.

DI stands for Directional Indicator.

The ADX indicator has three lines that reflect the price development: + DI line, – DI line, ADX line.

 

ADX Indicator Formula

 

 

Step 1

Determine the True Range (TR),+ Directional Movement (+DM) and – Directional Movement (-DM).

This will help to compute the +DI and -DI lines.

True range is the largest of these values:
Current High minus current Low
Current High minus previous Close (absolute value)
Current Low minus previous Close (absolute value)

+DM is equal to the current high minus the previous high if it is greater than the prior low minus the current low, else it is zero.

-DM is equal to the previous low minus the current low if it is greater than the current high minus the prior high, else it is zero.

 

Step 2

“Smoothen” these values over time period used in the ADX Indicator setting (usually 14 days). To keep thing simple, smoothening is discussed in a separate section after this.

 

Step 3

Divide the smoothed +DI by the 14-day smoothed True Range and Multiply by 100 to determine the 14-day +DI value, which is plotted as a line on the chart.

 

Step 4

Divide the smoothed -DI by the 14-day smoothed True Range and Multiply by 100 to determine the 14-day -DI value, which is plotted as a line on the chart.

 

Step 5

The Directional Movement (DX) equals the absolute value of the subtraction of +DI and -DI divided by the addition of +DI and – DI.

 

Step 6

The last step is to calculate the ADX.

Average Directional Index (ADX) is a 14-day average of DX. All further ADX values are smoothed by multiplying the prior 14-day ADX value by 13, then adding the current latest DX value and dividing this total by 14.

 

As mentioned earlier that “smoothening” will be explained later, so here it is.

First True Range (TR14) = Sum of first 14 periods of TR1
Second TR14 = First TR14 – (First TR14/14) + Current TR1
Subsequent Values = Previous TR14 – (Previous TR14/14) + Current TR1

 

How to use the ADX Indicator?

Many traders in stock market or forex and especially newbies, tend to minimize the stock market and its evolution to a single technical indicator. You may see that many traders will take a stand based simply on the indications provided technical indicators such as the MACD or the RSI for example, it is a serious mistake not to commit, neither with the ADX, nor with any other technical indicator. Besides, do not believe in the Holy Grail and think that the ADX will make you a rich man alone.

ADX should be considered a technical indicator and nothing more, just evaluate the information it provides and include it in our graphical analysis. The “old school” way of using the ADX is to draw a horizontal line on its level 20. As soon as the ADX crosses the level 20, then that usually means that there is a strong trend movement (bullish or bearish). Once this level is reached, it is not rocket science to know in which direction the market is heading, it simply jumps to the eye by observing the stock chart concerned. The most aggressive speculators (who practice scalping and day trading) may favour level 15 instead of level 30, so as not to position themselves in the market too slowly and take full advantage of the upward explosion or falling of the price.

The ADX indicator is plotted on a continuous graph of 0 to 100. And these values are measured as shown hereunder:

(i) 0 – 20 shows lack of trending market action

(ii) 25 – 50 an indication of a strong market trend

(iii) 50 – 75 shows a robust trend

(iv) 75 – 100 an indication of an extremely strong trend

 

In the chart below, you can see that the stock price was trading in range (range bound) as the ADX stayed below 20.

The green line is +DI line , the red line is the -DI line and the black line is the ADX line.

adx low example

 

Where to find the ADX technical indicator?

The ADX technical indicator is present by default on the different trading platforms offered by the stock market and forex brokers to their traders. Whether on platforms Kite of Zerodha, Meta trader or cTrader on FxPro, Trading Station of FXCM or on technical analysis platform of binary options broker Stockpair, the ADX technical indicator is present and can be directly integrated with your graphics.

 

Buy Sell Signals with ADX Indicator

First condition for the signal to be valid: the ADX must be above 20! Below 20, you can go your way since all the
signals generated by the ADX will be wrong.

Then, when the ADX passes the level of 20, it is necessary to observe the crossings between the curve + DI and -DI.

If the + DI crosses -DI up, the buy signal is valid. If it is -DI that crosses + DI up, then you have a sell signal.

And do not forget that these signals are valid only if ADX is greater than 20.

This is the simplest approach to financial markets with ADX indicator for your trading.

 

ADX Indicator Strategy

Trading ADX Breakouts

In this strategy you need to draw support / resistance levels or trend lines on the chart and once the ADX crosses the level of 20, you can take the trade as per the breakout or breakdown in the stock price.

As you can see in the chart below, the stock came to the support level and as soon as the ADX went above 20, there was a strong upmove. Similarly once the support was broken and the ADX crossed 20, there was strong selling in the stock.

adx breakout example

 

 

Trading DI Breakouts

For a DI breakout to be valid the prerequisite is that ADX must be above 20. The DI breakout occurs when the +DI makes a new high along with the price or the -DI makes a new high along with a new low in the price.

As you can see in the chart below, the stock rallied once there was a +DI breakout.

DI breakout strategy example

 

 

ADX Pullback Strategy

This is an amazing strategy that helps you to make a position amidst a strong trend in the stock. The strategy is simple wherein you first confirm the existence of a strong trend by ensuring that ADX is above 20 and then you look for pullbacks in the stock price towards the 20 day exponential moving average (EMA) to enter into the trade.

You can see in the chart below that the stock retraced to the 20 day EMA multiple times before rallying further each time.

Also note that the stock retraced to 20 day EMA later but it broke through it instead of taking support but that entry is invalid as the ADX is below 20 at that time.

adx pullback strategy example

 

 

ADX Reversal Pattern  – Change in Dominance

This is one of the most useful strategies using the ADX indicator as it signifies a change in dominance. You can simply identify whether bulls are in control or bears are in control and then adjust your position as per the situation. The buyers will dominate the sellers once the previous high of -DI line is broken by the +DI line and vice versa for sellers to dominate.

In the chart below you can simply observe that as soon as -DI broke the previous high of +DI there was a strong downtrend in the price. You can use this strategy to exit your position at the right time.

ADX Reversal Pattern Example

 

 

ADX Divergence Example

Divergence as the name suggests occurs when the price moves up and the ADX moves down or the price moves down and the ADX moves up.

As you can the see in the chart below, new highs were being formed but the ADX was continuously falling but was above 20. This suggests that the uptrend is weakening and about to get over soon and this is what happened.

ADX divergence example

 

How to use ADX indicator for intraday trading ?

The best time to enter a day trading position is when the ADX is above 25 and moving upwards. This is due to the fact that at this value, there are lots of strong trends. However, it does not work like this always. But if you wait on a daily basis for this value to be reached at the same time as the market price and make either a new high or low for the day, then you stand a better chance of finding very high trade breakouts.

As an Intraday trader, the ADX indicator is very helpful for trend display. It is ideal for helping you to find extremely active intraday moves. When you want to use it for intraday trading, the best approach is to use the Bollinger bands.

The ADX indicator can give you a more accurate clue whether the strength displayed is sustainable or not.

Besides that, the ADX is ideal for use to study the chart up to 30 minutes because it works to remove the rugged edges between an intraday trend and other general market trends.

When you are using the ADX, watch on how the DMI and ADX’s spike varies in the indicator. By following the spike, it will be easy to know whether it is trailing upwards or downwards. This is how an ADX indicator is useful for intraday trading. Within a short period of time, it gives you a chance to know the general market trend which is very crucial in intraday buying and selling.

 

ADX indicator setting

The ADX indicator has a default setting of 14 days/bars. The responsiveness of the ADX indicator decreases as the time period of the setting increases.

Depending on your convenience, you can change the settings to as high as 50 and to as low as 8. However, 18 also works quite well.

A relatively high period, for example 28, smooths out the average price development indicated by the ADX line that it has been displaying for a long time. This higher setting provides more reliable signals but indicates new trends rather late than early.

If you use a lower period, then you will recognize trends earlier but they might turn out to be wrong.

As an experienced trader you need to check whether a change in the ADX Indicator setting has a positive or negative impact onyour trading strategy.

To be a successful trader, it is paramount to know when a trend begins, its strength and when it ends. This knowledge is crucial because a trend is a fundamental market mode for any profitable trading. Therefore, having access to all these information in a timely and an accurate manner can play a significant role in maximizing your trading profits.

 

 

ADX indicator MT4

The modern software of the ADX indicator come installed with the MetaTrader 4 (MT4) which is a software that helps to automatically calculate the ADX strengths whether upward or downwards. The main advantage of the MT4 ADX indicator is that it helps to smoothen automatically the ADX graphs. This will ensure that you get a more accurate but slightly less smooth ADX graph.

In addition to that, when you choose the ADX, the MT4 will ask you to key in a value for a certain period. Also, you can as well select the colors that you want the indicator to display for the different lines e.g. +DI and —DI.

Most of the modern ADX indicators come included with the MT4 hence you do not have to download the software separately.

 

ADX indicator formula in Excel

You can calculate the ADX in excel using the steps below.

(a) If you are using a 14 bar setting, then in column A insert values 1 through 14. To get the total sum of these numbers insert =sum(A1 : A14).

(b) In columns B, C, and D put the market’s high, low and closing prices respectively.

(c) To compute the upwards move insert = (B1 — B2). This should be under column E

(d) In column, F compute the downward move as = (C1 — C2)

(e) To know whether the upward move is stronger than the downward move use =if(abs(E1)>abs(F1),1,-1) under column G

(f) To know whether the upward move is more than 0, then use =if(E1>0,1,-1) under column H

(g) To confirm whether the downward move is more than 0, insert =if(F1>0,-1,0) in column I

(h) To compute line +Dl, insert =if(G1+H1=2,E1,0) in column J

(i) To compute line —Dl, insert = if (G1 +I1)=-2,F1,0) in column K

 

Hope this guide on ADX Indicator was helpful for you. Incase you have any queries or doubts regarding the ADX Indicator,  you can comment below and it will be answered soon. You can also read our guides on other technical indicators such as RSI, MACD etc.

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