How to Trade with the ADX Average Directional Index
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How to Trade with the ADX Average Directional Index

I largely attribute this to the volatility of Bitcoin and less to do with a failure of the indicator. Now when it comes to combining the indicator with its cousin the ADX; I am not a fan. If you just look at the candlesticks and trend without price, you would surely think this was a home run trade.

DMI Crossover Strategy

Before selling a stock, we must analyze the trend of the particular stock in a weekly and monthly chart. If ADX is above 23  and the +DMI line moves downwards, which is from above to below the -DMI line then this indicates a sell signal. A Negative Directional Index (-DI) is the difference between current lows and previous lows.

Trend Direction and Crossovers

Wait for this low to be penetrated before abandoning the signal. This bullish signal is reinforced if/when ADX turns up and the trend strengthens. Once the trend develops and becomes profitable, traders will have to incorporate a stop-loss and trailing stop should the trend continue. The high on the day of the sell signal becomes the initial stop-loss. There are several downsides to using the ADX as a technical trading tool on its own. The ADX helps traders measure the strength of a trend but it may also provide them with false signals.

What is ADX indicator and how to use it in Trading

This book also includes details on Average True Range (ATR), the Parabolic SAR system and RSI. Despite being developed before the computer age, Wilder’s indicators are incredibly detailed in their calculation and have stood the test of time. Your strategy might involve using RSI for entry or exit signals and ADX to confirm the trend’s robustness. This multi-indicator approach can yield more robust trade signals.

  1. It is not a solicitation or a recommendation to trade derivatives contracts or securities and should not be construed or interpreted as financial advice.
  2. Smoothed versions of +DM and -DM are divided by a smoothed version of the Average True Range to reflect the true magnitude of the move.
  3. The plus DMI is typically plotted separately on a chart and can be used to identify upward trends in a market.
  4. The plus DMI measures the positive price movement in a given market, while the minus DMI measures the negative price movement.
  5. As the chart clearly shows, there are plenty of +DI and -DI crosses.

A strong trend emerged after the August bottom as ADX moved above 20 and remained above 20. The 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. Although Wilder designed his Directional Movement System with commodities and daily prices in mind, these indicators can also be applied to stocks. For a 5-minute chart, using a 14-period setting for the ADX indicator is common.

Therefore, chartists need to look elsewhere for confirmation help. Volume-based indicators, basic trend analysis and chart patterns can help distinguish strong crossover signals from weak crossover signals. For example, chartists can focus on +DI buy signals when the bigger trend is up and -DI sell signals when the bigger trend is down.

Crossovers can occur frequently, sometimes too frequently, resulting in confusion and potentially lost money on trades that quickly go the other way. These are called false signals and are more common when ADX values are below 25. That said, sometimes the ADX reaches above 25, but is only there temporarily and then reverses along with the price. ADX is plotted as a single line with values varying from zero to 100. When you take a trade, you must make sure that the Average directional index is moving upwards and is above 25.

The ADX at the top uses has a length of 5, the middle a length of 10, and the one at the bottom a length of 20. In the image below, you see how a high ADX reading, coupled with oversold RSI readings, preceded a market reversal. If the red line(-DI) is higher than the green line(+DI) that is generally an indication of a bearish trend. Conversely, if the green line(+DI) is higher than the red line(-DI) that is generally an indication of a bullish trend. The ADX line indicates the strength of movement over the period. The next time you think a trend is changing and you need to decide whether to stick to this “friend” or cut ties, consider trying the ADX to confirm the trend’s strength.

Our Trendspider review unveils insights into discovering the most powerful trading strategy development and testing service. We test ADX with the DMI derivative indicator on 5,000 years of data to discover the best settings and trading strategy. Like any indicator, the ADX should be combined with price analysis and potentially other indicators to help filter signals and control risk.

Conservative traders may want to wait for readings of 30 or above before employing trend following strategies. However, what we can tell you, is that you definitely should try to experiment with different ADX readings and threshold levels. If you were to take a look at the trading strategies we trade at the moment, you would notice that we use a wide range of ADX settings. In mean reversion strategies, a high ADX-reading may be used to enhance oversold signals in other indicators or conditions, since it indicates that the move leading down was a firm one. And as is often the case in mean reversion, sudden and prolonged moves in one direction tend to result in a market reversal. One can say that these bi-directional lines are like two strong animals (a bull and a bear) pulling the market in both directions.

Overall, the ADX is a valuable tool for traders looking to identify and analyze trends in financial markets. An oscillator is a tool used by technical analysts to make predictions about future changes in the market. These momentum indicators rise and fall between two extreme levels. They help traders determine overbought or oversold conditions in the market. An overbought asset is characterized by the higher extreme while the lower extreme indicates that an asset is oversold.

Unlike Stochastic, ADX does NOT determine whether the trend is bullish or bearish. When trading, it can be helpful to gauge the strength of a trend, regardless of its direction. In the AUD/NZD chart, there were 5 ADX signals and we marked each with a vertical line and an arrow indicating the direction of the signal. Now let’s connect all the dots and look at two markets and explore how the ADX indicator can help you to make sense out of these charts. On the screenshot below, we set the DI period setting to 1 which means that the indicator just compares the two most recent candles. This is a good way of understanding the DI calculations quickly.

This line is non-directional and is the difference between the positive and negative indicators. Together, these indicators help assess whether a trade should be taken long or short, or if a trade should be taken at all. As we mentioned earlier in the article, ADX can be used not only in trend following strategies but also in mean reversion, to define oversold how to use adx indicator conditions that are worth acting on. In those cases, the role of the ADX shifts from a being a tool that tells us when market strength is worth acting on, to one that shows when it has moved too far in one direction. A lot of our trading strategies use ADX, and while you may use the default 14-periods, you definitely should try some other values as well.

The Average True Range (ATR) indicator, and Parabolic SAR are two well-known examples. ADX doesn’t show the direction of the trend, but only the trend strength. The -DI line indicates the strength of negative movement and is calculated by taking away the previous day’s low from the current day’s low. The +DI line indicates the strength of positive movement and is calculated by taking away the previous day’s high from the current day’s high. Overall, these are some of the main factors that can affect the calculation of the ADX indicator.