Average Directional Index How to Use the ADX in Trading

It is important to ensure that you do not combine the wrong indicators, which can lead to indicator redundancy and overemphasising information. The index’s main line shows the trend strength – when buying volume exceeds selling volume and vice versa. If the index moves horizontally below level 20, the market is flat. If the index exits the 0-20% zone moving toward 100%, the rate of price change increases, i.e., the trend increases. The index value of 50-60% indicates the imminent end of the trend.

This means that investors could seek to buy or sell a trend if it falls below 50 on the index due to the indication that it could be set to reverse. Although this can be a useful metric, it can be difficult to maximize the potential for profits in the largely sentiment-based crypto landscape prone to rapid investor appetite changes. Calculating an Average Directional Index can be straightforward in concept.

Example scanners and strategies that use ADX DI

And when it comes to evaluating the strength of a trend, the Average Directional Index is a popular technical indicator for this purpose. A couple of weeks later, the ADX quickly drops below 25—which marks the end of the stock’s upward trend. Soon after that, the -DMI line crosses above the +DMI line and the ADX shoots up above 25 again, which means that the stock is about to go on a sharp downward trend. At this point, Lionel decides that now is the time to sell his shares before the stock’s value drops too far. While it might be nice to know what the hottest trends in fashion and music are, what if there was a way to figure out which investments are trending up and which ones are on the way down?

With this in mind, if the trend represents a consistent rise, then the ADV value will begin to flatten out. When forming the chart, Welles Wilder suggested that a strong trend can be found when ADX reaches a level beyond 25 with no trends present below 20. This shows that BTC has experienced a strong trend throughout 2023 despite evidence of weakening strength in February and March. The chart above shows that the GBPUSD pair was trading within a narrow range, and the indicator was fluctuating below 25. When the price broke below the lower bound of the range, the indicator was already above 25.

ADX Is a Valuable Trading Tool

The indicator is (mostly) displayed in the same window as the ADX-calculating two-directional movement indicator (DMI) lines. Created by legendary trader Welles Wilder in 1978, the Average Directional Movement Index (ADX) is a technical analysis tool used by traders to establish trend strength as well as trend direction. It is common investing wisdom that detecting and trading in the direction of a strong trend is a profitable strategy with minimal risk exposure. This is why ADX is one of the most popular indicators among traders of all levels. Functionally, the ADX is an excellent indicator for identifying the prevailing conditions in the market. Traders can easily determine whether a market is ranging or trending, and then  apply the appropriate technical trading strategy.

Therefore, figure out the optimal set of indicators and their combinations using demo retail investor accounts. As soon as ADX rises above 20%, open a short Forex trading position as -DI is at the top. The stop-out level is the previous candle Average Directional Index high, the yellow line. It’s reasonable to set a trailing stop instead of the regular stop. In the Levels tab, add fixed horizontal levels to visually limit the main range of movement of the indicator and overbought/oversold zones.

A Must-ReadeBook for Traders

This impulse often turns out to be a trap for many traders. It is often mistaken for a breakout of key levels, while it stays local without receiving confirmation and the price goes back to the flat corridor. We are waiting for the dotted +DI and -DI lines to start diverging and when the index line begins to exit the 0-20% zone at the same time. We open a trade in the trend’s direction 2-3 candles after the ADX crossed the 20th level. The best moment to exit the market is when +DI and -DI (after the maximum divergence) begin to converge and/or the index line goes down and crosses the 30% level. The oscillator was originally designed to be used in volatile derivatives markets — futures and options, which are considered complex instruments.

The signal wouldn’t work if the index declined but didn’t break below 25. 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.