Average Directional Movement Index (ADX)

Average Directional Movement Index (ADX)

Average Directional Movement Index (ADX): ADX indicates or shows the strength of any trend. Upward movement of this indicator shows upward trend and downward movement of this indicator shows downward trend. There are various directional movement indicators. Average directional movement index is a part of technical indicators with other movement indicators.

The other directional indicators are Minus directional indicator(-DI) and Plus directional indicator (+DI). The -DI and the +DI movements indicates the negative and positive price movements. The average directional movement index is the mean, or average of the directional index over a specified period.

As ADX shows the strength of a trend, if it is above 25 then it is indicating a strong trend. If its below 20 then there is no trend at all. If the ADX is going down from high values then it indicates that the trend is ending. So, it is advised not to invest in stocks with downward trend of ADX.

Average Directional Movement Index (ADX)

If the ADX is declining then it indicates that the trend is weakening and one should not trade in this trend as the market is less directional at that time. If the ADX has been low for a certain period of time and it is now showing the ADX is rising then it indicates that the trend is rising and one can trade in this trend. If the ADX is rising then it’s indicating strong trend of the market. ADX value is proportional to the slope of the trend. If the trend is a constant slope then the ADX tends to flatten.

Average Directional Movement Index (ADX)
Average Directional Movement Index (ADX)

The above figure shows the ADX and the plus and minus directional movement indexes. We can see that with the positive directional movement the ADX is also rising then with falling positive movement the ADX is falling and it is rising again when the positive is rising and being constant.

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ADX method of technical analysis only shows the strength of a trend and buying signal.one needs to be careful while reading or interpreting the ADX indicator because the ADX only shows the strength of a trend and not the market movements.

That means it doesn’t show if it is bullish or bearish market. In a bearish market the prices are going down but the ADX indicator is showing upward trend and in the bullish market the prices are rising and the ADX indicator is also showing upward trend. So, there are trend ranges where in if ADX is above 25, then the trend indicates strong bullish/bearish trend. ADX does not give information of market direction, it only indicates the strength of a trend.

Average Directional Movement Index (ADX)
Average Directional Movement Index (ADX)

Waiting for the indicator to go above 25.

The ADX indicator showing above 25 signals a strong bullish market. So, before looking at the market movements first we should wait for the ADX indicator to get above 25. But as the trend can’t develop without the prices in the market changes so in order to estimate the trend, we need to first examine the actual price action.

  • Waiting for the price to have a bearish trend to sell.

The last 50 candlesticks may indicate the trend. If the prices are going low during these 50 candlesticks then the market is heading to bearish trend, this the time to sell. This trend gives sell signal.

  • RSI indicator breaks and shows below 30.

For the entry signal RSI indicator is used. If its below 30 then it indicates oversold market. So, when the ADX indicator shows the strong signal, more and more sellers would come to the market. So, when the RSI breaks and goes below 30 we sell.

Stop loss should be placed in the last high ADX

The point where the last ADX made it to high should be identified and then find the corresponding high on the price chart and there you place the stop loss.

Average Directional Movement Index (ADX)
Average Directional Movement Index (ADX)

Before the ADX goes below 25 one should take profits because the ADX below 25 shows weakening trend. A strong trend give you profit but as the strong trend turns to downward trend then the profit should be taken before it breaks below 25 and wait for the strong trend opportunities.

ADX is a good indicator????

ADX is best for screening stocks and writing scans. One can eliminate the stocks which are in trading range. We can divide the stocks by strong trends and weak trends. ADX does not give buy or sell signals. It just indicates the trend of the stock. Low trends indicate trading range or beginning of the trend. Very high trends indicate that the trends won’t last long.

Conclusion

ADX with other combinations of indicators gives accurate trend signals. It when combined with price gives a strong strength signal. While using the combination, first it is important to use ADX to know whether the prices are trending or not trending then one should use other trading strategy for the situation at that point of time. Finally, we can say that best profits are reaped by gauging strong trends and best ADX strategy will help one to attain trading goals. By using ADX indicator one can take advantage of the strength of trend and make quick profits.

Average Directional Movement Index (ADX)
Average Directional Movement Index (ADX)

We get profits when we trade the strongest trends and avoid range conditions. ADX not only determines trending conditions, it also helps one to find the strongest trends to trade. ADX has the ability to quantify the trend strength which is a major advantage for traders. ADX also determines range conditions, so one doesn’t get stuck trying to trend trade in sideways price action. In addition, it shows when price has broken out of a range with sufficient strength to use trendtrading strategies. ADX also gives information to the trader about the changes in trend momentum, so risk management can be handled. If one wants the trend to be a friend, then better let ADX become your friend first.

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