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Monday, January 12, 2009

ADX Indicator

Otherwise known as the Directional Movement Index is another of the J Wells Wilder systems discussed in his book "New Concepts in Technical Trading Systems" The ADX is a trend following system that comprises 2 parts the actual ADX which determines the strength of a trend and the directional index +DI and -DI which assist with exact entry points when they cross.

The ADX is scaled between 0 -100 with readings below 20 signifying a weak ranging market. A break through the 25 signalling the start of a possible trend and breaks above 30 signify a directional trend. A break above 40 indicates a strong directional trend.

This indicator does not specify market direction, it only indicates trend strength without telling you the market direction. In a falling market the ADX line will still be rising in a strong down trend so do not be confused and think a strong rise in the ADX line indicates a strong bullish market, it can just as easily be a strong bear market.

Click to enlarge
On the above chart the thick blue line is the ADX trend indicator, the green is the +DI and the red is the -DI

Most charting packages will include the Directional Index lines + DI and -DI. These lines are used to determine entry points for trades. On the following charts the + DI line is green and the - DI line is red. When the +DI(green) crosses the - DI(red) in and upward direction this is the buy signal and when the -DI(red) crosses the +DI(green) in an upward direction this is the sell signal. In both instances we would only enter the trade once the ADX crosses above 25 and stay with it if the ADX goes above 30.

When the ADX is below both DI lines then the market is clearly ranging and flat and not a good time to contemplate any new trades and even more so when all the lines are below 20 as can be seen in the first chart.

The +DI and -DI can sometimes be tricky to follow and I suggest using them in conjunction with another trend following indicator to confirm trade entries. Like all technical Indicators it is probably best to test it using different settings time frames and indicators to see which suits your trading style best. Click to Enlarge
As we can see from the above chart the shaded area is where the +DI and -DI lines cross for a potential Buy on the GBP/USD pair. At the time of the cross the ADX was still below 20 indicating a ranging market. I have used a MACD Line indicator to confirm the trade but the ADX still takes a few hours to confirm the long trend. The end result however was still a potential 300 pip trade.

4 comments:

Jenai said...

You are in my top ten Entredrop award. Just gave you some linky love on my blog. I love the charts by the way.

InvestSound said...

Very informative and helpful post. I never liked the ADX coz the way it looked :) it looked confusing to me and could never understand what it was showing. Well, I think now I can go back and review it.

Thanks!

manoballs said...

Fantastic! i might need this robot on my trading. :)

- Forex Trader

Elizabeth said...

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