The average directional index determines the strength of a trend. But unlike other well-known indicators, like the RSI, it doesn't show whether the trend is bullish or bearish. ADX shows the following:
ADX is a calculated value that represents the average of the Positive Directional Indicator and Negative Directional Indicator, and it's always positive. Here's a chart that illustrates different ADX ranges and what they mean.
Absent or weak trend
Very Strong trend
Extremely strong trend
|ADX Value||Trend Strength|
|0-25||Absent or weak trend|
|50-75||Very Strong trend|
|75-100||Extremely strong trend|
Many traders believe that when the ADX value is above 25, it indicates a strong trend to follow. If ADX is below 25, it suggests a time when assets are either being collected or distributed. When ADX stays below 25 for about 30 time periods, the price tends to move back and forth between support and resistance levels as buyers and sellers try to figure out their positions. After this period of uncertainty, the price often starts a new trend.
In technical trading, it is crucial to interpret ADX correctly. It is important to keep in mind that ADX does not indicate a trend reversal. Basically, it determines whether the trend is strong enough. People sometimes mistakenly think that a decreasing ADX means a trend is changing direction. In reality, a falling ADX just shows that the existing trend is becoming weaker. You can use a straightforward rule of thumb to understand ADX.
Following are the steps involved in calculating directional indicators: Calculate the true range (TR): It represents the maximum amount a price has moved in a single period.
Calculate the directional movement (DM): It is the difference between the current high and the previous high (for DI+) or between the current low and the previous low (for DI-). Using a moving average, smooth the DM values.
Formula for DI+ and DI: DI+ = 100 * smoothed DM+ / TR DI- = 100 * smoothed DM- / TR
The formula for ADX: ADX = 100 * Average of |DI+ – DI-| / Average of DI+ + DI-
By looking at the highest points of ADX, traders can figure out how strong the trend's momentum is. When these peaks are high, it means the price's momentum is powerful. But when the peaks are low, it hints that the momentum is getting weaker.
When there's a rising trend momentum, it encourages traders to hold onto their profits without leaving the trade. On the other hand, ADX divergence is a sign that momentum is dropping, which means it's a good time to consider using a tighter stop-loss to protect your investment.
ADX is a useful tool for trading strategies. It helps traders know when a breakout in the price is strong enough to become a trend. Breakouts happen when buyers and sellers don't agree, causing the price to change direction. But not all breakouts become successful trends. ADX helps you identify when a breakout is powerful enough to follow. When ADX goes above 25, it's a sign of a strong trend to track.
ADX indicators are also handy for figuring out the price range. When ADX drops from above 25 to below 25, it means the trend is weak and the price is moving sideways. This ADX level will persist until there's a shift in the balance between supply and demand.
By combining ADX with price information, you can create a winning trading strategy. It lets you know when the price is following a trend, and you can use that to decide your trading approach. When the price is in a trend, you can use pullbacks as entry points.
While ADX is a helpful tool, it has its drawbacks to remember:
ADX indicator measures trend strength. Additionally, it helps you recognise when the price isn't trending, so you don't waste time trying to follow a trend. It's also handy for managing risks because it signals when the momentum is slowing down. If you want to be successful with trend trading, you can't ignore the ADX indicator.
The Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI) and Bollinger Bands are the most common indicators used with the ADX.
The average directional index (ADX) tells you when the price is trending strongly.
Traders use the ADX indicator to identify strong market trends. ADX indicator above 25 is considered a strong trend. Therefore, traders use ADX indicators to look for opportunities to enter trades in the trend direction.
ADX is a lagging indicator.
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