How to use ADX indicator or Average Directional Index?
Apparently J Welles Wilder did not just develop a tool to analyze technically on the forex market.
In principle, this indicator shows when the trend starts, how strong the trend is and when the trend is weakening.
This indicator became popular in a book written by J Welles Wilder in his book titled “New Concepts in Technical Trading Systems”
The Average Directional Movement Index (ADX) is a technical indicator to measure the momentum of the forex trading market.
And to analyze the forex trading market or financial instruments in trending or not.
TenkoFX broker, a brokerage firm that serves forex traders to trade on the forex, CFD and crypto trading markets.
Regulated by the International Financial Services Commission (IFSC) of Belize.
What is ADX Indicator?
ADX is one indicator that functions to measure the strength of the trend of financial assets and as a lagging indicator (giving a signal after the trend is formed on prices).
At first, ADX was to analyze commodity prices but then to analyze the forex and stock markets.
This indicator is a combination of three lines, namely the Average Directional Index (ADX) itself, + DI and -DI.
Average Directional Index (ADX) shows the strength of the trend regardless of the direction of movement of the trend.
Meanwhile, + DI and -DI complement ADX by displaying the direction of current price movements.
Using ADX makes it possible to help when the trend starts, how much strength the trend has, until the time the trend starts to weaken.
Therefore the ADX indicator is very useful for traders in analyzing market trends, especially for traders who use market trends to get profit.
ADX calculation is based on the Moving Average of the price over a certain period.
A common setting is period 14, but you can also use other periods.
Another name of ADX is the Directional Movement Index (DMI)
ADX Indicator Formula
The ADX indicator formula is very complicated in its calculations, on the MetaTrader platform to call the ADX Indicator is to click Insert -> Indicator – >> Trend – >> Average Directional Movement Index.
You don’t need to count manually because your platform has already calculated automatically.
But if you want to know the ADX formula, below is the formula used
Source from Investopedia
- +DM or Directional movement = Current high – Previous high
- -DM = Previous low- current low
- CDM=current DM
- ATR= Average true range
How to read ADX Indicator
The ADX indicator is useful to calculate the strength of a trend, regardless of whether the trend is rising or falling.
`ADX Display has three main components in the graph.
- + DI: a line to measure the strength of a trend when it is an uptrend in a certain period.
- -DI: a line to measure the strength of a trend during a downtrend at a certain period.
- ADX: a combination of the two lines + DI and -DI, which has been filtered with Moving Average.
What needs to be understood is that ADX does not show the direction of the trend but to measure how strong the direction of the trend is.
In the graphic display, the ADX line is in a new window below the candlestick.
For example, the three components of the ADX indicator can be seen at the image below
When the ADX line moves up, it is possible for the trend to strengthen and the market has a great chance to continue the trend in the same direction.
Conversely, if the ADX line is down, it means the trend is weakening and there is a possibility that the trend will reverse.
The measure of the strength of the trend is generally using parameters in the numbers 0 to 100, and divide into four categories.
- ADX value 0-25 assessment as a weak trend.
- 25-50 assessment as a strong trend
- 50-75 assessment as a very strong trend.
- 75-100 assessment as an extremely strong trend.
If the ADX indicator is below the 25 levels or below both the + D and -D lines, the market conditions are ranging.
The price moves in the area between the Support Resistance level, before determining the direction of the next trend movement.
When the market is sideways, it is safer to no trade until finding a strong trend again.
How to use ADX indicator effectively
ADX is not an indicator to determine the direction of the trend, but it is to measure the strength of the trend, thus how to use the ADX indicator effectively is to pay attention to the value of ADX.
We will try to take an example in the EURCHF pair below.
In the image above pair EURCHF, the ADX value has remained below the 20 marks from late September to early December.
And during that time range, the movement of the EURCHF pair is sideways or flat.
Then in early January, the value of ADX began to rise above the number 50.
And this gave an indication that a strong trend could wait ahead.
And it turns out then the EURCHF pair moved down with a strong around 400 pips.
You can imagine if you have open short it will record a profit of around 400 pips, this is an effective way to make a profit.
Let’s take another example but in the same pair, only the conditions are different, see the image below.
In the example above, the EURCHF pair uses a daily timeframe, the same as the first example, the ADX value has been at 20 for a long time.
And when the ADX value is 20, we see that the price conditions are also sideways or ranging.
But when the ADX value has reached 50 then we see that the trend is very strong.
But the opposite of the first example, which is in a downtrend, whereas in the second example in an uptrend.
Prices move more than 300 pips and you will pre-book when you open Buy at the beginning of a trend.
From the two examples above we draw the conclusion that ADX is not to determine the trend up or down, but rather serves as a measure of the strength of the trend.
If the ADX value drops from 50, then the possibility of the trend will start to weaken.
In the example above the + D and -D lines are not available.
While on the MetaTrader platform there are three lines, namely the ADX line, the + D line and the -D line.
The most important thing is to understand the value of ADX, while + D and -D are determinants of uptrend and downtrend.
- When the + D line crosses the -D line from below, the next trend will rise.
- Vice versa when the + D line crosses the -D line from above, the trend will go down.
Using ADX to determine the exit point
The ADX indicator is very useful as a confirmation whether the pair may be able to continue the current trend or not.
You can also combine ADX with other indicators, as a way to determine whether the trend will bullish or bearish
For example with Parabolic SAR, this will help especially identify whether the pair is downtrend or uptrend by looking at how Parabolic SAR works.
While the way to determine the exit point based on ADX is when the ADX value has started below the number 50 then you can close the position immediately.
Assuming that when ADX started sliding below 50, this shows that the current trend is starting to weaken.
Because maybe after a weakening trend there can be a reversal of the trend.
So before this happens you have gone out first to secure profit.
Advantage and disadvantage using ADX indicator
- + ADX indicator can be used on all currency pairs.
- + It can also be used for all timeframes and trading styles.
- + Good to identify the strength of the trend as momentum trading.
- – This indicator is lagging, so it is too late to give a signal.
- – ADX cannot be used to determine the trend.
After learning about how to use ADX this indicator will certainly add to the existing toolbox as a tool in conducting market analysis.
Indeed, you can use this indicator alone.
But it would be better if it combines with other indicators that have different functions so that it will be a filter to get a better signal.
Because this indicator has a function to measure the strength of the trend,
Although this indicator a lagging . with your experience, hence you will find the way how to recognize early trends will start.
So your profit will maximize.
For most day traders they use H1 timeframes, Although you can use H4 timeframes, the signals will appear less frequently.