In forex trading, a golden rule is to always trade trends but it is important to trade strong trends. A popular tool to find and measure the strengths of trends is the ADX indicator.
Therefore, the ADX is a trend indicator although it is non-directional. It is non-directional because it merely shows the strengths of trends and not the direction of these trends.
The average directional index (ADX) is an oscillator just like the RSI and stochastic. Similarly, its readings are also graphed within a scale.
What Does The ADX Indicator Tell You?
As mentioned, the ADX does not indicate whether the market is bullish or bearish. Rather, it is used to filter out ranging markets from trends.
Generally, strong trends have a high reading. The stronger the trend, the higher the reading of the ADX indicator.
When the reading of the ADX is low, the market is ranging or consolidating. Market orders are not placed in this region.
Also, if the ADX rises above 50, this indicates that momentum is high and a trend has started.
ADX Indicator Calculation
The ADX is calculated based on a moving average of price range expansion over a certain period of time. It compares the highs and lows of bars but the close of the bars is not used.
Since the ADX is non-directional, its readings are generated from two-directional indicator (DMI) lines.
Usually, the default setting of the ADX is 14 bars, this can be edited on every trading platform.
Interpreting the Values of The ADX
The ADX values help traders identify ranging and trending markets. These values are used to approximate the strength of trends as well.
ADX readings above 25 indicate a strong trend. Conversely, when ADX is below 25, the market is either accumulating or distributing so trades are avoided.
A complete breakdown of the ADX indicator’s readings is shown in the table that follows:
|ADX Value||Trend Strength|
|0-25||No trend/ Weak Trend|
|50-75||Very Strong Trend|
|75-100||Extremely Strong Trend|
Trend strength is increasing when the ADX line is rising, the price moves in the direction of the trend. When the line is falling, the trend strength is decreasing, the price enters a period of retracement.
How To Trade With The ADX Indicator
The ADX can be used to determine when a currency pair will continue its trend.
Most importantly, since it does not predict the market’s direction, it has to be used with another indicator. This indicator is better suited as a secondary indicator for confirmations.
For instance, the ADX can be used with a moving average. A moving average crosses candlesticks to signal a buy or sell order.
The ADX indicator is checked to verify every entry of the moving average signals. A rising ADX indicates a strong trend starting; ideal market condition.
Also, the ADX can be used to determine whether trade exists. When the ADX starts to fall below 50, the trend is weakening. This is your cue to close the trade or take profits before a reversal occurs.
Lastly, breakouts can be found with the ADX. If the ADX readings have been below 25 for a while, a gradual rise from this region indicates a breakout from a consolidation period.
As with every oscillator, the ADX indicator also exhibits divergence. A divergence occurs when this indicator forms highs and lows that diverge from the current highs and lows on the price.
In the example above, the price made a lower high but the ADX made a higher high. The price and ADX did not correlate, hence, signifying a loss in momentum.
Divergences are not a sign of reversal but they show that momentum might be shifting.
Furthermore, when the price makes a higher high and the ADX makes a lower high, there is a negative divergence.
The ADX indicator is an amazing tool. Trading in the direction of the trend increases returns while reducing risks. As a beginner, it can be quite difficult to recognize trends correctly.
Adopting the ADX indicator helps find strong market trends and teaches discipline.
Although the ADX is non-directional so it has to be paired with another indicator that specifies the market’s direction.
The period to set the ADX to solely depends on the type of trader you are. When the ADX is set to a low value, its sensitivity increases. Care is to be taken, but it is ideal for day traders.
On the other hand, the 14-period is ideal for long-term traders.
Leading indicators predict future price action before it occurs.
The ADX is a lagging indicator, it follows price action rather than predicts it. In this case, the ADX does not predict trend changes but rather just displays price action.
Summary; How To Use The ADX Indicator In Forex
The average directional index is a recommended tool for traders that struggle with trend trading.
With the ADX, risk management is improved because momentum can be monitored. Hence, positions are not held blindly.
A drawdown with this indicator is it only determines the strengths of trends. Therefore, other strategies or indicators have to be used alongside it.