Trading will be more profitable for you if you execute it correctly. Thus, there are indicators specially designed to understand the strength of trends or at least parts of them. The Average Directional Movement Index (ADX) is an indicator that shows both processes. In this blog, let’s explore the Average Directional Movement.

J. Welles Wilder discovered the Average Directional Movement Index in 1978 as an indicator of trends of strength in a series of prices of financial instruments. It is a widely used indicator for technical analysts and is provided as a standard in collections of indicators offered by various trading platforms.

What is the Average Directional Movement Index?

The Average Directional Movement Index (ADX) will tell you about the trend, whether it is strong or weak in the price of a security. This ADX ranges from 0 to 100. If it’s value is below 25 then the trend which you’re analyzing is weak. If your value is more than 25, then the trend you are chasing is strong and getting stronger.

By using ADX value, you can make buy or sell decisions. The onset of a weak trend is a signal to sell, while an incoming strong trend is a signal to buy. There are two indicators, first one is the Positive Directional Indicator (+DI), which measures the strength of a positive trend. The next one is the Negative Directional Indicator (-DI), which measures the strength of a negative trend.

From these two directional movement indicators, you will get some values that are smoothed and averaged to show you the ADX value. More than a Smoothed Moving Average (SMA), some even use Exponential Moving Average (EMA), OR Weighted Moving Average (WMA).

How to Use ADX Indicator

Simply put, the Plus Directional Indicator and the Minus Directional Indicator, both of which can be used for trend analysis, are combined to create the complex indicator known as the ADX. The indicator move is often thought to reflect the strength of the current trend. Growing in importance as a trend-following indicator, rising ADX indicates a market trend that is strengthening. The trend development is unlikely, according to falling ADX. A neutral trend can be evident if the ADX number is less than 20. The utility of oscillators is increasing.

Is ADX a Good Indicator?

Identifying your trend strength can be helpful in trading any security. This ADX will be a better job to determine trends’ strengths. Like any other indicator, Average Directional Movement Index too has its pros and cons. As far as strengths are concerned, this adept at combining the +DI and –DI indicators to give you solid information about trend strength and crossover signals. This helps you to figure out if a trend exists at the top.

Whereas, if there are many crossovers happening very often, it may provide you with good trading signals that lead to potentially bad trading decisions. Whether the Average Directional Movement is good or bad, it should fit your trading style. You can use it with other indicators too, like the Relative Strength Index (RSI). So that’s another advantage you can focus on.

How to Interpret the Average Directional Movement Index?

ADX will only tell the strength of a trend, without considering the positive or negative trend. So ADX is a non-directional indicator. You can use it for your trades, but only after understanding how to interpret each possible ADX value.

If your ADX value is less than 20 there is no trend, if the value is 25 it’s a weak trend, if the value is more than 25 it’s a solid trend, if its value is 25-50 it’s a strong trend, if the value is from 50-75 its very strong trend, if its ranges form 75-100 it’s an extremely strong trend, but it’s very rare.

ADX Indicator Formula

To determine the Average Directional Index, it’s compulsory to find the positive directional movement (+DI) that’s the difference between today’s and yesterday’s highest price, and the negative movement (-DI) which is the difference between today’s and yesterday’s lowest price. Then the moving average of the directional movement is calculated.

ADX Trading Strategy

The main motto of ADX’s trading strategy is to identify the strongest trends and distinguish between trending and non-trending conditions. If the readings of ADX are above 25 it indicates trend strength, when it is below 25, this shows trend weakness. Breakouts are not difficult to spot, and also help to identify whether it is strong enough for the price to trend or not.

So when ADX rises from below 25 to above 25, trends are consider to be strong enough to continue in the direction of the breakout. It is a usual misperception that when this line starts, this is a sign of trend reversal. It only means that the trend strength is weakening. If ADX is above 25, it should be consider that a falling ADX line is simply less strong.

Various market timing methods have been devise using ADX. These methods are discus by Alexander Elder in his book Trading for a Living. One of the best buy signals is when ADX turns up when below both Directional lines and +DI is above –DI. You can sell when it turns back down.

Using ADX Strategy with Forex

ADX is commonly use within highly liquid markets. Forex trading is the most liquid financial market. This indicator, when applied to currency trading. Helps measure a currency pair’s strength to see whether the instrument will decrease or increase in price. Using this method will reflect its trend momentum and indicate the presence of either an upward or downward trend.

Final Thoughts

ADX is one of the most reliable trend strength indicators and has help several traders determine ranging markets correctly. And avoid being entice into buying false breakouts or investing in markets that are essentially flat and going nowhere. ADX calculations can be complex, and interpretations can be straightforward, but successful implementation takes practice. Like other technical analysis tools, the ADX should be combine with price analysis. And potentially other indicators to help filter signals and manage risk.

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