Wells Wilder developed the Average Directional Index (ADX) and
introduced it in his classic investment
book “New Concepts in Technical Trading Systems” which was published back in
the 1970s and today, the Average Directional Movement indicator remains one of
the most popular among FX traders. Let’s look at the ADX indicator in more detail
and how, you Can use it in your currency trading strategy, to generate more
accurate trading signals and make bigger profits.
ADX and the Strength of Trends
The ADX is a defined as a momentum indicator, the purpose of which is to simply
measure the strength of a trend. The indicator will if applied correctly, give
you an idea of if the market is
trending, or is trading sideways in a range.
The
Advantages of using the ADX
Most currency traders have heard the saying “a strong trend in motion is more likely to
continue, than reverse.” and if you always trade strong trends, you can make a
lot of money - but to do this, you want to know if the market is trending and
how strong the currency trend actually is and this is where the Average
Directional Movement indicator can help you.
How to Calculate the ADX
The ADX is based on the comparison of two directional indicators, both of which
were developed by Wilder, and they are:
Positive Directional Indicator (+DI) and the Negative Directional Indicator
(-DI) to produce ADX as showed in the following formula:
ADX = SUM[(+DI-(-DI))/(+DI+(-DI)), N]/N
Where:
N: Refers to the period of calculation. The formula presented above then
produces the ADX line, which oscillates between 0 to 100 values. The +DI and
-DI are both present and can be seen to make up the indicator.
You don’t need to understand the above calculation to use the indicator,
because all major FX Chart services plot it and you can see it visually at a glance
and when you know how it works, the direction of the trend is obvious.
Using the
ADX Indicator
The ADX indicator sole purpose is to indicate the strength of the trend and
this means, other indicators should be used to enter, and exit trades, its therefore
a back up indicator and needs to be combined with other momentum indicators to
generate trading signals and the stochastic, RSI and MACD, are popular
indicators to combine it with.
Although the ADX fluctuates from 0 to 100, it very rarely gets above 60.
You can use the ADX in the following way:
Readings above 40 indicate the strength of the trend.
Readings below 20 indicate range trading and flat periods of consolidation.
You can use the crossing of +DI and -DI to see the trend direction; when +DI
crosses -DI to the upside, it’s a bullish signal, conversely, when +DI crosses
-DI downward it’s a bearish signal.
The ADX line if used correctly will always help you trade with the strongest
trends and give you advance warning of
changes in momentum.
Final Words
Everyserious trader should make the ADX
line part of their essential FX Trading education and if you want an indicator
which can help you trade trends better and more profitably then, the AVERAGE Directional
Movement indicator is an essential one to study – so incorporate the ADX in
your FX trading system and see how it can help you make bigger profits.
