The Average Directional Index (ADX) was plotted to help traders to find trending markets and determine trend strength to remain on the optimal side of a trade. This indicator has earned its place as a staple in analytical trading strategies for 40 years. This ADX is use to identify whether the market is ranging or starting a new trend. ADX is a non-directional indicator. It is categorize by comparing the highs and lows of bars and does not use the close of the bar. If there is a strong trend, the reading will large regardless of whether it is a downtrend or uptrend. In this blog, let’s explore how to use the Average Directional Index in Forex, and ADX Forex trading strategy.

How to Use the ADX Indicator in Forex Trading?

ADX signal is an absolute value, a positive number measuring the strength of either a positive or negative trend. This is used to plot the potential for market changes depending on the movement of values. If the ADX moves over 25 points from its lower values, attention is given as it approaches the 40 lines. The ADX gives trading signals when the two minor DM lines cross one another, with special consideration given to peaks in the signal line. Further, let’s have a quick look at how to use the average directional index indicator.

Measures of Momentum Strength

A trend is said to be a weak trend if it stays below a value of 25. A trend is said to be strong if its value ranges from 25 to 50, and it can be even register in high range for very strong and extremely strong trend variations. Those values below 25 are classified as an accumulation or distribution phase, although there are exceptions.

The key observation for a trader at this juncture is that prices always break out of ranging behavior, the breakout will be stronger if the period is long. But more than anything, your patience matters here.

DM Crossovers

During ranging periods, crossovers are not necessarily indicative of what may come. You should take note of DM crossovers if the signal line is above 25 and prepare for changes in price direction. Whereas, it is also important to understand that the peak in the signal line is not a signal of an imminent price reversal. Whether the success peaks are up or down, is an ongoing report that the momentum of price changes is increasing or decreasing. During the up periods, the trend is your friend.

Benefits of Using the ADX

For beginners, the ADX provides traders with more precise exit and entry points. While ADX moves above 25 and continues to rise, many traders view it as an invitation to enter a trade. If any reading is below 25 it indicates the trend is ending and exiting the trade close to the 25 lines will have less profit potential because the trend is either just beginning to form or steadily weakening.

Thus, the traders use higher value, like 40 as their trade entry and exit point. Because ADX movements above 40 indicate a strong trend and the greatest profit potential. A trend may continue in the same direction as the ADX falls between 40 and 25, the price will consolidate as the trend strength diminishes, thereby reducing the trader’s potential profit margin. So, observing peaks and dips can also give traders a sense of market momentum.

Risk Factors of Using the ADX

Traders may generally use the ADX as a trend indicator. But it does pose limitations that traders should be aware of. You can also find whether the trend is bullish or bearish by using the ADX along with the +DI and –DI. It is one of the biggest weaknesses of using this on its own. Sometimes, the ADX fails to provide accurate guidance in terms of signals to use when exiting a position.

Traders’ actions are based on certain levels in the ADX range. But the indicator itself leaves the guesswork to the trader. The ADX provides the inescapable limitations of being a lagging indicator, which means traders are always operating off past data to understand potential price movements. Some traders choose to pair the ADX with leading indicators that may be useful in corroborating its suggestions.

Important Concepts with ADX

Volatility and Volume are the first things to be consider while using the ADX indicator. This is a valuable tool because it focuses on the trend and strength of the stocks. Whereas, extremely volatile stocks will not always adhere to ADX readings. Stocks that are favorable to the ADX will have high volume but not so high volatility.

The next one is divergence, unlike other indicators’ divergence in ADX does not predict a change in trend. The trend is said to be intact, as long as the value stays above 20. Generally, this is based on the moving average. Thus, it is very slow to react or in other words, it is a lag indicator. ADX is not capable of providing signals for slow-moving or less volatile stocks.

A Simple ADX Indicator Trading Strategy

Generally, Forex traders employ technical analysis to determine optimal exit and entry points in the market. They focus on the ADX key points of reference, which are high points and line crossovers. With any technical indicator, an chart will never be 100% correct in the signals it presents. But the signals are enough till the odds are in favor of the trader and provide an edge. Only by experience, does the skill in interpreting and understanding ADX signal comes.

Simply, determine your exit and entry points when the green line crosses the red line in an upward movement, accompanied by the signal line moving above 25. Implement a buy or sell order for no more than 2% to 3% of your account. Try to place a stop-loss order at 25 pips below your entry point.

Bottom Line

The Average Directional Moment Index indicator can be a formidable tool in your Forex trading toolbox. But it will be so effective when combined with other technical indicators. By learning how to use this helpful indicator and incorporate it into your daily routine is best achieve with hours of practice trading on a free demo system.

Visit us on: www.milliva.com