The purpose of Average Directional Indicator (ADX) is to calculate when a price is in a robust trend. The benefits of knowing this are that dealing when you are following a trend that is strong can improve your potential to make profit as well as minimising your risk. ADX can be used to put a value on the strength of a trend. The ADX is calculated by basing the expansion of a price range moving average over a specific time period. The standard time period is for this to be 14 bars but clearly this can differ. To plot ADX, a line containing values spanning from zero to 100 is drawn. The key with ADX is that it doesn’t follow a direction – only the strength of a trend is captured and if a particular price is generally moving upwards or downwards. The ADX is normally shown alongside the 2 Directional Movement Indicators (+DMI and -DMI) that comprise the ADX. If the –DMI is below the +DMI, the prices are generally trending upwards. Thus, ADX will reflect how strong that upward moving trend is. Similarly, when +DMI is below the –DMI, the prices are generally trending downwards and ADX will reflect how strong that downward moving trend is. Measuring the strength of a trend Traders use the ADX number to seek out the most robust and lucrative trends to deal. This ADX value is also invaluable to identify which conditions are genuine trends and which aren’t The benchmark that traders will use to signify a trend is strong enough to start dealing is an ADX in excess of 25. If an ADX value is 25 or below, most traders will take that to mean that a trend is too weak to deal. A guide: ADX between 0 – 25 means a weak trend ADX between 25 – 50 is a trend strong enough to trade ADX between 50 -75 is a highly strong trend ADX between 75 – 100 is an excellent trend

Low ADX Values When ADX values fall below 25, this normally means that distribution or accumulation is happening. If this continues in excess of 30 bars, the price now becomes part of ‘range’ conditions and so any patterns in the price become clearer to spot. The price will then vary upwards and downwards moving from the resistance (upper price limit) and support (lower limit) to determine the relevant selling and buying prices. Gradually, weak ADX circumstances will reveal a price that becomes a trend. To understand how strong the trend is, the important aspect of the ADX line is its direction. A rising ADX signifies that the strength of the trend is moving upwards. The price will also move in the trend’s direction. If the ADX line drops away, then this shows that the trend is weakening and the price will now consolidate. Most people mistakenly view the ADX line in decline as a sign that the trend is moving into reverse. However, unless the price has reached its maximum all this signifies is that the trend is not as strong. As long as ADX stays above 25, the trend is still there albeit a little weaker. The Momentum of trends Momentum is the speed of the price. The general ‘momentum’ of a trend can be demonstrated by a range of spikes in the ADX values. The ADX will easily show at what point a trend loses or increases this momentum. So, when the momentum of a trend is rising, this will be reflected by a range of higher ADX spikes. Likewise, a falling momentum of the trend is shown by a range of lower ADX spikes. It follows that an ADX spike in excess of 25 is robust even if not as high as others. Don’t think that just because ADX momentum is falling when a trend is moving upwards that prices won’t increase. The best dealers do not get carried away by instinct but stick to objective signs. Any dealer noticing a range of smaller ADX spikes should take this as a sign to monitor price and control risk. Likewise, a dealer can allow gains to continue while the momentum of a trend is rising instead of panicking and leaving the trend early.

So, once a trend is no longer following the same pattern, one should assess how this situation should be handled so as to control any risk. Conclusion: Seek out the strongest trends The most profitable trades will emerge from the strongest trends. As ADX helps find these, dealers can identify which ones to deal and putting a number to these occurrences make them easier to spot. As ADX can also reveal the weaker trends, any dealer will know which ones to avoid. And you can control your risks by using ADX for momentum changes.

ADX Indicator

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