ADX was created by Welles Wilder in 1978, the Average Directional Movement Index (ADX) is a technical analysis tool used by traders to speculate 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. This is the primary reason for this much popularity among traders. The ADX is an excellent indicator for identifying the conditions in the market. Thus, the traders can easily find whether the market is ranging or trending, then apply the appropriate technical trading strategy. In this blog, let’s explore ADX indicator trading strategies.

What is the Average Directional Index (ADX) Indicator?

Simply, the Average Directional Movement Index (ADX) is a single-line oscillating indicator that ranges from 0 to 100. Only the strength is indicate by the ADX and not its direction. In other words, the ADX is a non-directional indicator, which means it measures the strength of a trend but does not differentiate between uptrends and downtrends. During the strong uptrend, the ADX rises, and while in the strong downtrend, the ADX falls. Simply, when the market is trending, notify a trader, and to stay on the right side of the market, filter out counter-trend trades.

Trading ADX Signals

The ADX delivers several price signals that can be trade in the market and learning how to trade these signals, could enhance your trading accuracy. These signals include crossovers, finding ranges, and breakouts.

Crossovers

The motto of using the ADX is to focus only on trading qualified opportunities in trending markets. That’s why watching out for crossovers of the +DI and –DI lines is important. When –DI is less than the +DI line, it implies that the rate of positive price change in the market is greater than the negative price change. If this happens when the ADX is above 25, it is a solid signal to place buy orders.

When –DI is greater than the +DI line, it implies that the rate of negative price change in the market is greater than the positive price change. The signal is said to be solid signals if this happens when the ADX is below 25. Crossovers are as much a trigger for trade entry as they are for trade management and exits. For example, if you are in a long position and the –DI line crosses above +DI, you can seek to protect your capital by locking in partial profits using trailing stops or by exiting your trade position entirely.

Finding Ranges

In markets, the ADX is one of the trusted ranges. When the ADX reading falls below 25 and stays there for an extended period, it means that the market is trendless or ranging. These ranging markets are characterize by the price bouncing off recognizable support and resistance areas. In markets like this, buy orders are place off support areas, and sell orders are place off resistance areas.

Breakouts

Eventually, the ranging market is bound to break out. Usually, breakouts will happen frequently in the markets, and they can offer a tremendous opportunity for traders. Even though breakouts can be easily found, it can be very difficult to determine whether a breakout is valid or not. Also, several fake breakouts can leave traders trapped in critical trade positions. Breakouts can be easily validated with the help of ADX. That is when the price breaks out with an ADX reading of above 25, which shows that momentum in the new direction can be sustain. But the breakouts with an ADX reading of below 25 are potentially unsustainable.

Reading the ADX Indicator

Simply, the ADX line is primarily a momentum indicator. Based on this, a rising ADX implies a strengthening trend, a falling ADX implies a weakening trend. By watching the +DI and –DI lines, trend direction is determine. When the +DI is above –DI, an uptrend will be place. Whereas a downtrend is in place when –DI is above the +DI. When both +DI and –DI crosses, it indicates that a trend reversal is occurring. If +DI crosses above –DI, the trend is said to be bullish; whereas if the –DI crosses above +DI, it is said to be bearish. It will be a case of a particularly strong trend if a cross occurs when the ADX line is also going up.

ADX Calculation

There are three lines in the ADX indicator, they are +DI (green line), -DI (red line), and ADX (black line). There are certain formulas to calculate these lines, further let’s see about the calculations:

+DI = ((Smoothed MA + DM)/ATR) * 100

-DI = ((Smoothed MA – DM)/ATR) * 100

DX = ((+DI – -DI)/ (+DI + -DI)) * 100

First ADX = sum n periods of DX/ n

After that, ADX = ((Prior ADX * n-1) + Current DX)/n

Where,

+DM = Current High – Previous High

-DM = Previous Low – Current Low

ATR = Average True Range

N = Number of periods used in the calculation (the default is usually 14, but traders can adjust this according to their needs).

The three lines of the ADX indicator’s calculation are plot above. And +DI is a positive directional indicator, whereas –DI is a negative directional indicator. The ADX is non-directional and is plot from 0 to 100, with no negative values.

Final Thoughts

ADX is a leading indicator that is used to maximize your profits by indicating where to buy and sell stocks. By using a simple technical analysis tool, you can double your accuracy and get better results. Both short-term and long-term traders use this in the stock markets. Simply, there is no trend trading during low ADX times. Usually, the best traders begin from low ADX periods. If ADX divergence takes place, get out of the trade immediately. ADX shows you when a trend is about to end or change direction.

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