Part 2 Technical Analysis – How To Use The ADX Indicator

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Part 2: Technical Analysis – How To Use The ADX Indicator

For today, I have prepared a short talking about the ADX indicator. It can be easily used for your bussiness strategy.

Preview of ADX indicator

Average Directional Index is an oscillator, that shows values between 0 and 100. These values show the strength of the current rising or falling trend, or confirms non-trend market. Values around 20 indicate weak / stagnating trend, whereas when ADX indicator shows a value around 50, we have a strong trend going on and values over 70 are very rare and mean a truly strong trend.

ADX curve itself does not show us whether this is a trend of decline or rise, but there are DI curves for that, in addition we should be able to identify if the price rises or falls by ourselves by now. If the ADX curve grows, the strenght of the current trend rises also and vice versa. +DI and -DI curves can also serve as a small signal to enter the trade. More on this in a different article, though.

Example of trading using ADX

This version of the indicator is a little older and does not contain DI curves, but it will still serve us. In our case the ADX curve kept orbiting around the value of 20. Therefore there was no trend to speak of – the price was stagnating. Out of nowhere, the price has gone into uptrend and the ADX indicator rose to levels over 50. Do we understand how the indicator works, yet? ��

ADX indicator comes with one problem. It will not tell us exactly when to enter or exit a trade. What it tells us though is, whether it is a good idea to enter a trade with the direction or against the direction of the trend.

How to trade using the ADX?

There are two ways you can trade using the ADX which are: against the trend or with it. However that is for a longer talk and we can look forward to it in a different article.

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I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author

Average Directional Index – ADX Definition and Uses

What is the Average Directional Index (ADX)?

The average directional index (ADX) is a technical analysis indicator used by some traders to determine the strength of a trend. The trend can be either up or down, and this is shown by two accompanying indicators, the Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI). Therefore, ADX commonly includes three separate lines. These are used to help assess whether a trade should be taken long or short, or if a trade should be taken at all.

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Key Takeaways

  • Designed by Welles Wilder for commodity daily charts, but can be used in other markets or other timeframes.
  • The price is moving up when +DI is above -DI, and the price is moving down when -DI is above +DI.
  • Crosses between +DI and -DI are potential trading signals as bears or bulls gain the upper hand.
  • The trend has strength when ADX is above 25. The trend is weak or the price is trendless when ADX is below 20, according to Wilder.
  • Non-trending doesn’t mean the price isn’t moving. It may not be, but the price could also be making a trend change or is too volatile for a clear direction to be present.

The Formulas for the Average Directional Index

(ADX) Indicator are

The ADX requires a sequence of calculations due to the multiple lines in the indicator.

Calculating the Average Directional Movement Index (ADX)

  1. Calculate +DM, -DM, and True Range (TR) for each period. 14 periods are typically used.
  2. +DM = Current High – Previous High.
  3. -DM = Previous Low – Current Low.
  4. Use +DM when Current High – Previous High > Previous Low – Current Low. Use -DM when Previous Low – Current Low > Current High – Previous High.
  5. TR is the greater of the Current High – Current Low, Current High – Previous Close, or Current Low – Previous Close.
  6. Smooth the 14-period averages of +DM, -DM, and TR. The TR formula is below. Insert the -DM and +DM values to calculate the smoothed averages of those.
  7. First 14TR = Sum of first 14 TR readings.
  8. Next 14TR value = First 14TR – (Prior 14TR/14) + Current TR
  9. Next, divide the smoothed +DM value by the smoothed TR value to get +DI. Multiply by 100.
  10. Divide the smoothed -DM value by the smoothed TR value to get-DI. Multiply by 100.
  11. The Directional Movement Index (DX) is +DI minus -DI, divided by the sum of +DI and -DI (all absolute values). Multiply by 100.
  12. To get the ADX, continue to calculate DX values for at least 14 periods. Then, smoothe the results to get ADX
  13. First ADX = sum 14 periods of DX / 14
  14. After that, ADX = ((Prior ADX * 13) + Current DX) /14

What Does the Average Directional Index (ADX) Tell You?

The Average Directional Index (ADX) along with the Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI) are momentum indicators. The ADX helps investors determine trend strength while -DI and +DI help determine trend direction.

The ADX identifies a strong trend when the ADX is over 25 and a weak trend when the ADX is below 20.

Crossovers of the -DI and +DI lines can be used to generate trade signals. For example, if the +DI line crosses above the -DI line and the ADX is above 20, or ideally above 25, then that is a potential signal to buy.

If the -DI crosses above the +DI, and ADX is above 20 or 25, then that is an opportunity to enter a potential short trade.

Crosses can also be used to exit current trades. For example, if long, exit when the -DI crosses above the +DI.

When ADX is below 20 the indicator is signaling that the price is trendless, and therefore may not be an ideal time to enter a trade.

The Difference Between Average Directional Index (ADX) and the Aroon Indicator

The ADX indicator is composed of a total of three lines. The Aroon Indicator is composed of two. The two indicators are similar in that they both have lines representing positive and negative movement, which helps to identify trend direction. The Aroon reading/level also helps determine trend strength, like the ADX does. The calculations are different though, so crossovers on each of the indicators will occur at different times.

Limitations of Using the Average Directional Index (ADX)

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. This is 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.

Like any indicator, the ADX should be combined with price analysis and potentially other indicators to help filter signals and control risk.

Technical Classroom: How to use ADX Indicator for profitable trading

ADX is non-directional; it registers trend strength whether price is trending up or down.

Narnolia Financial Advisors

Technical Analysis Classroom: Part 21

Detecting a strong directional move is the most important skill for all traders to have. Trend chasing is the most popular technical method of profitable trading. But stock prices spend more time in consolidation and less time in trending move and so trend trading are prone to frequent drawdown. So before employing trend trading it is important to know whether the stock is in a trend or not.

The ADX indicator simply measures the strength of a trend and whether the price is in a trading or non-trading price movement. The ADX indicator by J. Welles Wilder is a wildly popular indicator for measuring strength of a trend. Unlike the RSI, ADX doesn’t determine whether the trend is bullish or bearish; but it measures the strength of the current trend.

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What is ADX Indicator?

The ADX (Average Directional Index) is a creation from technical analysis legend J. Welles Wilder which gives following important information.

• It informs a trader when the market is trending.
• It filters out anti trend trades to help trend chasing indicators from frequent whipsaws.

Figure .1.Illustration of ADX indicator

Construction of ADX Indicator

Using following three indicators together, chartists can determine direction as well as strength of the trend.

Figure .2.Construction of ADX indicator

As mentioned above the ADX is comprised of the following components:

1. Plus Directional Movement Index (DI+)
2. Minus Directional Movement Index (DI-)

ADX itself is the smoothed average of the difference of the DII+ and DII-. ADX cannot have a negative value.

Figure .3.Components of ADX Indicator

The above chart indicates the visualization of the ADX.
• Green Line = DI+
• Red Line = DI-

• Black Line = ADX

Interpretation of DI

While ADX provides information only about the strength of the trend, it is normally supplemented with Directional Index +DI and –DI for knowing the direction of the trend.

Their interpretation is as follows:
• When +DI is above -DI then trend is considered as an uptrend.
• When -DI is above +DI then trend is considered as a downwards.
• +DI is crossing over -DI signals trend reversal to bullish trend.

• -DI is crossing over +DI signals trend reversal to bearish trend.

Interpretation of ADX

• If the price is going UP, and the ADX indicator is also going UP, then we have the case for a bullish trend.
• The same is true if the price is going down and the ADX indicator is going UP. Then we have the case for a bearish trend.

• Value of ADX below 20 is called trading zone which implies non-trending market.

ADX strength scale

• If ADX is between 0 and 20 then the stock is in a trading range. It is likely just chopping around sideways. Avoid these for trend trading.
• Once ADX gets above 20 then start employing trending trade system. Big moves (up or down) tend to happen when ADX is right above this number.

Figure .4. Strength scale of ADX Indicator

Important concepts with ADX

Volatility & Volume: – The ADX is a valuable tool because it focuses on the trend and strength of the stocks. However extremely volatile stocks will not always adhere to ADX readings. Stocks that react favorably to the ADX should have high volume but not very high volatility

Divergence: – Unlike other indicators divergence in ADX does not predict change in trend. As long as the value stays above 20, the trend is intact.

Trading the Trend

• If the price is going UP, and the ADX indicator is also going UP & its value above 20 and +DI > – DI, it is a buy signal.
• If the price is going down and the ADX indicator is going UP & it is above 20 and -DI >+ DI, it is a sell signal.

Figure .5. Trading the Trend with ADX indicator

Trading the Ranges

When ADX is below 20, price enters a sideways or consolidation. When ADX rises above 20, price tends to trend. Low ADX is a usually a sign of accumulation or distribution.

When ADX is below 20, price enters range conditions, and price patterns are often easier to identify. Price then moves up and down between resistance and support to find selling and buying interest, respectively.

Figure .6. Trading the range with ADX indicator

This chart displays an ADX value that is below 20 and so the stock was in a tight range, which is perfect for range trading.

Weakness of ADX

• ADX is based on Moving Averages. Therefore it is very slow to react or in other words it is a lag indicator.
• ADX may not provide signals for slow moving or less volatile stocks.
• Crossover of +DI and -DI sometimes can happen too frequently, thereby giving many false signals.

• Unlike other indicators ADX cannot be used in isolation and should be used with other oscillators or indicators.

Conclusion

• The Average Directional Index (ADX), Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI) represent a group of directional movement indicators that form a trading system developed by Welles Wilder.
• ADX is non-directional; it registers trend strength whether price is trending up or down.

• When the +DMI is above the -DMI, prices are moving up, and ADX measures the strength of this uptrend. When the -DMI is above the +DMI, prices are moving down, and ADX measures the strength of this downtrend.

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