How to Use ADX
In a wide range of indicators, there are only some that determine the trend's strength. For any trade, it's essential to understand whether the trend is strong or weak. It's vital knowledge that helps traders to open successful trades. ADX is one of the technical tools that show whether the trend is sharp. If this article is not enough for a complete understanding, you can also check out how to use ADX in another source.
ADX: Meaning
Average Directional Index or ADX is a technical tool that defines the trend's strength. J. Wells Wilder Jr. invented it in 1978. The index is based on a moving average of price range expansion over a certain period.
The ADX is represented by three lines:
- The first one is ADX itself. The curve moves within the 0-100 range. It's used to define the strength of the current trend, not its direction.
- The next one is the +DMI or Plus Directional Movement Indicator, which is built as a difference between two consecutive maximums.
- The third line is the -DMI or Minus Directional Movement Indicator. It's opposite to the previous curve. The -DMI is a difference between two bottoms.
ADX: Reading Signals
Let's have a look at ADX signals.
The ADX curve shows whether an asset is trending. As the line moves within the 0-100 range, there are certain levels that are used to define trend's periods.
- If the ADX is below 25, it's a sign of an absent or weak trend. Usually, the price moves within ranges when the indicator moves between 0 and 25 levels. Thus, a trader should avoid trading a trend and choose range-trading strategies.
- When the ADX climbs above the 25 level, there are odds the trend gains momentum. The 25-50 range signals a strong trend. The 50-75 zone is a sign of a very strong trend. Any reading above 75 is a sign of an extremely strong movement.
There is another interpretation of the index's ranges:
- A 0-20 range signals a lack of trend when traders try to avoid placing orders and raise transaction volumes.
- A range of 20-30 can signal a start of a trend. There are risks of a fake breakout.
- A 30-40 range can be considered as the best entry point as it confirms the trend.
- A 40-50 zone reflects a sharp trend. A trader can either add to a position or just keep the trade open.
- A 50-100 area shows the trend can come to an end. It's worth closing the trades.
Based on this information, we can create a common rule. ADX peaks signal the momentum of a trend. When each next ADX peak is higher than the previous one, traders can keep their trades open as the trend becomes more solid.
When the ADX curve forms lower peaks, the trend is weakening. It doesn't mean the trend will end immediately. Still, a trader should be careful and closely monitor the market. Regarding the market conditions, it may be wise to move stop orders closer to the current price or take profits partially.
ADX Classic Signals
Although the ADX indicator is used to define the trend's strength, not its direction, two other curves can provide a clue on the trend's movement. It's common that when +DMI is above -DMI, bulls prevail in the market. Vice versa, when -DMI is higher than +DMI, bears are stronger.
It's also possible to combine +DMI, -DMI, and ADX to get signals:
- Traders can buy when +DMI moves above -DMI, while ADX is above 25. +DMI can break below -DMI later, but it doesn't cancel the buy signal as long as the low of the signal day holds.
- Traders can sell when -DMI breaks +DMI bottom-up and ADX is above 25. Stop-loss orders can be placed at a high of the signal day.
Tips for Traders
In this section, we will give some recommendations on how to use the ADX indicator:
- The ADX is effective only during strong trends. If the price moves sideways, there are high risks of fake signals.
- The indicator is not helpful on low timeframes as it provides numerous fake signals. Apply this technical tool on hourly and higher periods.
- Although the indicator can be used to define the trend direction, its primary function is to reflect the trend's strength. Use additional tools that can confirm the direction of the trend.
- The most reliable signal occurs after the price exits the consolidation period. A larger number of fake signals occurs when the major trend changes its direction.
- Any reading below 25 is a sign of the lack of the trend. When the indicator rises above the 25 level, the trend gains momentum.
The ADX indicator helps define a trend's strength. It's a useful tool. Still, traders should be careful as it can provide many fake signals. That's why it's recommended to combine the ADX with other technical indicators.
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