The calculation part of the ADX indicator is a complex process. However, the most important thing is to understand that a higher ADX is often accompanied by a stronger price trend. People often apply ADX in short- and medium-term trading effectively. In this way, trading with strong trends can help reduce risks and increase profit opportunities for investors. The ADX Moving Average Index plays an important role in determining when the price trend is strong. Join Forex Trading to learn what ADX is, and how to calculate and apply it effectively, which will be an important factor to help traders make smart decisions.
What is ADX?
ADX (Average Directional Index ) is an important technical analysis tool. Used to evaluate the strength of a trend over time.
What is ADX?
Based on the average difference between directional (+DI) and opposite direction (-DI) indicators, which are then smoothed.
The structure of ADX includes three main lines: ADX, +DI, and -DI. When ADX < 25. The market is usually in a horizontal state, with a clear price trend. When ADX > 25, there is a strong sign that a new trend is about to take place. Regardless of price increase or decrease.
Mr. Welles Wilder, the developer of ADX, created it for the commodity market. But then it was widely applied in the stock market. Mr. Wilder introduced ADX in the book “New Concepts in Technical Trading Systems” in 1978. Accompanied by ATR, Parabolic SAR, RSI, and MA road. Although developed before the computer era, Wilder’s indicators were extremely detailed and far ahead of their time.
ADX is considered a unidirectional index that measures trend strength relatively well. Often used to distinguish horizontal trends and prepare for new trends.
However, ADX also has disadvantages. It cannot determine the direction of the trend, only measure the strength or activity level of the current trend. A high ADX does not necessarily mean a bullish or bearish trend. At the same time, ADX can provide inaccurate signals when the ADX value is below 25. A decrease in ADX is not necessarily a sign of a trend reversal unless there is a price peak.
Meaning of ADX indicator
The ADX indicator is an important tool that helps traders determine price trends. Build a trading strategy that suits you. Accordingly:
When the ADX line crosses above 25 and +DI crosses above -DI, this usually indicates a strong upward price trend. Conversely, if ADX crosses 25 but -DI crosses above +DI, the price trend is usually strongly bearish.
Assessing the strength or weakness of a trend, ADX provides valuable information. If ADX is below 25, the market trend is usually weak, while above 25 the trend is usually very strong. ADX has a maximum value of 100, and when it is between 75 and 100, the price trend is very strong.
See more: Average line What is Forex that cannot be ignored?
The indicator also provides trading signals to market participants. If +DI surpasses -DI and ADX surpass 50, it is usually a good time to open a BUY order, because the uptrend is very strong, and buyers are dominant.
If +DI is below -DI and ADX still exceeds 50, it means the price is falling sharply, and sellers have the advantage. At this time, finding an entry point for a SELL order is often a reasonable choice.
Formula to calculate the ADX indicator
To calculate the ADX indicator, we rely on a moving average. Extends the price range over a fixed period, usually 14 sessions.
To determine +DM and -DM, we use the formula:
- +DM = Highest price in the current session – previous session
- -DM = Lowest price in the current session – previous session
Although calculating ADX can be complicated, in general, a high ADX usually corresponds to a strong trend. When ADX is low, it often indicates periods when prices move sideways or trade in a tight range.
Structure of the ADX indicator
The ADX indicator includes three main lines: ADX line, +DI line, and -DI line.
The ADX line, usually represented in dark blue, is calculated over 14 trading days. The value of the ADX line ranges from 0 to 100, from the lowest to the highest level. ADX does not have a specific direction, but it records the strength or weakness of the trend whether the price is increasing or decreasing.
The -DI line is shown in red, while the +DI line is shown in green. The ADX indicator and two directional movement lines DI are often plotted in the same frame.
When the +DI line is above the -DI line, this usually indicates that the price is trending up and ADX measures the strength of this trend, giving buyers the upper hand.
On the contrary, when the price reverses and the -DI line crosses above the +DI line, it is often a sign of a downtrend, and the ADX at that time will measure the strength of this downtrend, giving sellers the advantage. than.
In short, the ADX line often provides signals about new market trends, while the +DI and -DI indicator lines assist in determining the buying and selling forces of the market.
Role of ADX indicator
- The ADX indicator can be applied to all types of trading assets. From stocks, mutual funds, and exchange-traded funds to futures contracts.
- Not only does it help identify trend conditions. ADX also helps traders identify the strongest trend to open orders.
- In addition, ADX also helps identify criminals. Helps traders avoid difficulties when trading in conditions of sideways price fluctuations.
- Additionally, ADX provides alerts on fluctuations in trends. Helps traders establish effective profit and risk management strategies.
Instructions for using the ADX indicator to trade Forex
To successfully use the ADX indicator in Forex, traders need to pay attention to the following:
How to read what is ADX Index
The ADX indicator became popular because of its ability to provide a significant amount of information.
The ADX main line shows the strength of the trend. While the +DI and -DI sub-lines help determine the direction of the trend.
When interpreting the ADX index, remember that it is only part of the overall picture. To confirm the signal, it is necessary to analyze the position of the three indicator lines relative to each other and within the range from 0 to 100%. Below, I will present each signal in detail.
How the ADX indicator works
Build ADX indicator on MT4
Step 1: Open the currency pair’s chart in the terminal by clicking File — New Chart in the top menu.
Step 2: Apply the ADX indicator on the chart. At the top menu bar, click Insert -> Indicators -> Trend -> Average Directional Movement Index.
Step 3: Set parameters as follows:
- Period: Number of candles used to calculate the indicator value. The default value is 14, meaning the EMA is smoothed over the last 14 candles.
- Adjust: Used to modify the levels set on the indicator chart.
- Color: Change the color and line style of +DI and -DI indicators.
- Levels: Add fixed horizontal levels to limit the indicator’s main movement zone and overbought/oversold zones.
- Display: Define the timeframe you want to display in the same window when switching to charts of other timeframes.
Build ADX on LiteFinance terminal
Setting up the ADX indicator on the LiteFinance terminal on your account is more convenient and practical than MT4. Here you will find everything you need, combining active trading with social trading. Perform functions without having to register.
Start by applying the indicator to the chart of the required currency pair. Click on the settings icon and enter the necessary parameters.
Installation parameters include:
- ADX smoothing: This is a sensitivity parameter, the larger the value, the less sensitive the main indicator line is to price fluctuations. Typically, keep it at 14 until you get the hang of adjusting the indicator for each currency pair.
- DI length: This is the period (number of candles used for calculation).
- Precision: This is the number of decimal places for the levels, the default is 4.
Period and DI length are important parameters. The default value is 14 but can be adjusted depending on the currency pair and current volatility. Other commonly used values are 12, 14, 18, and 21. Going beyond the range of 7-30 is not necessary:
- When the period decreases, the indicator will increase the speed of movement and provide more signals.
- As the cycle increases, the indicator will react more slowly to apparent price movements. The number of false signals will be less but due to lag, the indicator may provide signals too late.
How to use the ADX indicator forex
Now that we have discussed the theory, let’s take a look at some real-life examples of using the ADX indicator in Forex trading.
To clarify, when two Forex trading conditions are satisfied simultaneously, it will be a signal for you:
- The dotted lines meet and begin to diverge.
- When they meet, the main line is below the 20% level, and then, the dotted lines start to move up.
The meeting is indicated by an arrow. As soon as ADX rises above the 20% level, open a short position because the -DI line is at the top. The stop-out level is determined by the height of the previous candle. Marked in yellow. It makes sense to use a trailing stop instead of a regular stop.
Start looking for exit opportunities in the forex market when the dotted lines are at their maximum distance and begin to converge. In the red-marked area, the index reverses in the area next to the reversal of the dotted lines. This means that foreign exchange trading activities are weakening. This is also confirmed by candlestick analysis when trading forex – red candlesticks have shorter bodies with each subsequent candlestick. Close the position as soon as you notice the first green candle.
The profit potential of about 90 points in 4-digit quotes.
The ADX indicator recognizes sideways movement
The main index line is suitable for detecting sideways movements in the market. If you want to remove the presence of dotted lines, you can do this in the settings in the Style tab.
In 1 minute, the index line remained below 25% for 5 hours. The price chart shows a narrow sideways style. Clear with widths under 10pts at 4-digit prices. When it comes to such spreads in a zone like this, only scalping trading strategies work.
Use ADX to look for trends
Let’s look at a real example of opening an order. I will demonstrate how to analyze charts and execute trades. During the process of the order being placed on the market, I will continue to explain and share with you its results.
Trading in a sideways trend usually only attracts scalpers, whose profit target is a small number of points. However, the greatest profits are often achieved through trend trading. When prices change rapidly, and the intensity of the trend increases, trading becomes more profitable and faster.
ADX has two strengths:
- Doesn’t let you get stuck in a sideways trend because it provides warnings about the start and end of the trend.
- Shows the strength of the trend – the speed of price increase.
However, one weakness of the ADX indicator is latency. On the other hand, opening orders for a long time, and waiting for an extended trend using lagging signals is considered one of the prudent, low-risk, and perfect trading strategies.
Now, try opening a trade based on the information provided in this review. I would find the starting point of the trend using ADX and enter the market.
Preliminary analysis
The situation in point 1 was presented at the beginning of this analysis. When the index moves out of the 0-20 zone after +DI and -DI intersect, the -DI dotted line is already rising, indicating a downtrend.
After September 23, the trend began to weaken – the main line began to decline and the dotted lines began to approach. This shows that the downtrend is fading. By noon on September 25, all three indicator lines were approaching each other at a point below the 20% level. This is a sign of a sideways trend. Then there are clear signs of a change in trend direction.
At point 2, the dotted lines intersect and displace – this is the first signal of an increasing movement. The second signal appears when the green candle breaks the resistance created above the highs of the significant downtrend. ADX remains below 20%.
Open order
One of the effective technical analysis strategies is to evaluate the market situation on the higher timeframe and open orders on the lower timeframe. The analysis is performed on the H1 timeframe (a screen image was taken previously).
Here are the observations:
- Break resistance level;
- A row of bullish candles;
- +DI and -DI divergence towards an uptrend;
- ADX reversed to increase in the lower zone.
Then, switch to the M30 timeframe. Although not recommended, intuition and improvisation are important in trading. Here, I see similar conditions but the ADX indicator has crossed the 20% level. With a delay of one candlestick, I open an order with 1 lot. While observing the order being opened, I also continue to monitor the situation on the hourly timeframe. After 30 minutes, the oscillator rose above the 20% level on the hourly time frame. All these signals show a change in trend very clearly.
The H4 timeframe also presents an interesting situation. Here, there is a crossover of the dotted lines along with a trend change signal. But our indicator has crossed the 40 level and ADX is decreasing. This may indicate that you should close open orders within 30 minutes of the day.
Close order
On the hourly timeframe, the ADX indicator is falling, showing a convergence of the dotted lines. It would be possible to close the position on this candlestick and with that, my profit potential would be just over $30. A pretty good number for low-risk trading strategies.
See more: Prestige Broker XTB: Elevate position of invest player
However, I decided to keep the order open for the following reasons:
- Chart analysis shows that the overall downtrend is likely to end. Therefore, a large downward candlestick is only a temporary occurrence.
- The oscillating indicator on the H4 frame shows that +DI and -DI continue to diverge with the growth of the index line.
After the review, you will be informed about the results of your attempt to find a new trend and whether it was successful or not. As well as the possibility of prices continuing to move in a downtrend.
Additionally, how to work with screening tools will be discussed through screenshots and real-life examples in a review of another indicator, the RSI, and also with analysis.
Conclude
Practice the ability to react flexibly. The trading conditions described above may fluctuate based on specific market conditions. If you need examples of how to use these indicators, or if you don’t know how to download what ADX is in the edited version, you can refer to the documents shared from Forex Trading.
Frequently asked questions about what is ADX
What role does the ADX indicator play in Forex trading?
In Forex trading, the ADX indicator has the role of measuring the strength of the trend. Provides signals about market conditions. Helps traders identify trends and make reasonable trading decisions.
What does ADX help traders do when the +DI and -DI lines intersect?
When the +DI (Positive Directional Indicator) and -DI (Negative Directional Indicator) lines intersect. ADX provides signals about changes in market trends. When +DI exceeds -DI, this is a positive signal for the uptrend, and vice versa.
At what point should a trader open an order according to the ADX indicator?
Traders should open orders when the +DI and -DI lines intersect and the ADX indicator rises above the 20% level. This is often a signal of a strong trend forming.
