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

Every  serious 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.