How to use ADX Indicator to Trade Stock & Binary Options

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How to Use the ADX Indicator

The ADX indicator measures the strength of a trend and can be useful to determine if a trend is strong or weak. High readings indicate a strong trend and low readings indicate a weak trend.

When this indicator is showing a low reading then a trading range is likely to develop. Avoid stocks with low readings! You want to be in stocks that have high readings.

This indicator stands for Average Directional Index. On some charting packages there are two other lines on the chart, +DI and -DI (the DI part stands for Directional Indicator). Ignore these lines. Trying to trade according to these two lines is a great way to lose money!

The only thing that we are concerned with is the ADX itself.

Note: This indicator measures strong or weak trends. This can be either a strong uptrend or a strong downtrend. It does not tell you if the trend is up or down, it just tells you how strong the current trend is!

Let’s look at a chart:

In the chart above, the ADX indicator is the thick black line (arrow). The other lines are the +DI and -DI (ignore these). The highlighted areas show how this indicator identifies trading ranges. ADX is showing a low reading and the stock is chopping around sideways.

Now look at what happens when the indicator gets into higher territory. A strong trend develops! These are the type of stocks that you want to trade.

On the right side of the indicator panel you will see a scale from 0 to 100 (only 0 through 80 are marked). Here are my guidelines for using the scale:

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ADX indicator scale

If ADX is between 0 and 25 then the stock is in a trading range. It is likely just chopping around sideways. Avoid these weak, pathetic stocks!

Once ADX gets above 25 then you will begin to see the beginning of a trend. Big moves (up or down) tend to happen when ADX is right around this number.

When the ADX indicator gets above 30 then you are staring at a stock that is in a strong trend! These are the stocks that you want to be trading!

You won’t see very many stocks with the ADX above 50. Once it gets that high, you start to see trends coming to an end and trading ranges developing again.

The only thing I use the ADX for is an additional filter in my scans, so that I can find stocks that are in strong trends. I do not even have the ADX indicator on the charts that I look at when I am looking for setups. Since the ADX is already factored into the scans, I don’t need it added to the chart itself.

I don’t pay any attention to the rising and falling of the ADX indicator. Stocks can go up for long periods of time even though the ADX may be falling (indicating that the trend is getting weak). The ideal scenario is that the ADX is rising, but I don’t find it necessary to take a trade.

I don’t use any technical indicators on my charts. I found out that technical indicators just clouded my judgement. One technical indicator may indicate a buy and one may indicate a sell. Needless to say, this can be very confusing and it just takes you attention away from the only thing that matters – PRICE.

So what is the ADX indicator good for?

This indicator is best used for screening stocks and writing scans. By adding this indicator to your scanning software, you can eliminate all of the stocks that are in trading ranges. You can then set up your scan to find only those stocks that are in strong up trends or strong down trends.

The ADX indicator does not give buy or sell signals. It does, however, give you some perspective on where the stock is in the trend. Low readings and you have a trading range or the beginning of a trend. Extremely high readings tell you that the trend will likely come to an end.

ADX: The Trend Strength Indicator

Trading in the direction of a strong trend reduces risk and increases profit potential. The average directional index (ADX) is used to determine when the price is trending strongly. In many cases, it is the ultimate trend indicator. After all, the trend may be your friend, but it sure helps to know who your friends are. In this article, we’ll examine the value of ADX as a trend strength indicator.

Introduction to ADX

ADX is used to quantify trend strength. ADX calculations are based on a moving average of price range expansion over a given period of time. The default setting is 14 bars, although other time periods can be used.   ADX can be used on any trading vehicle such as stocks, mutual funds, exchange-traded funds and futures.

ADX is plotted as a single line with values ranging from a low of zero to a high of 100. ADX is non-directional; it registers trend strength whether price is trending up or down.   The indicator is usually plotted in the same window as the two directional movement indicator (DMI) lines, from which ADX is derived (Figure 1).

For the remainder of this article, ADX will be shown separately on the charts for educational purposes.

Source: TDAmeritrade Strategy Desk

Figure 1: ADX is non-directional and quantifies trend strength by rising in both uptrends and downtrends.

When the +DMI is above the -DMI, prices are moving up, and ADX measures the strength of the uptrend. When the -DMI is above the +DMI, prices are moving down, and ADX measures the strength of the downtrend. Figure 1 is an example of an uptrend reversing to a downtrend. Notice how ADX rose during the uptrend, when +DMI was above -DMI. When price reversed, the -DMI crossed above the +DMI, and ADX rose again to measure the strength of the downtrend.

Quantifying Trend Strength

ADX values help traders identify the strongest and most profitable trends to trade. The values are also important for distinguishing between trending and non-trending conditions. Many traders will use ADX readings above 25 to suggest that the trend is strong enough for trend-trading strategies. Conversely, when ADX is below 25, many will avoid trend-trading strategies.

ADX Value Trend Strength
0-25 Absent or Weak Trend
25-50 Strong Trend
50-75 Very Strong Trend
75-100 Extremely Strong Trend

Low ADX is usually a sign of accumulation or distribution.   When ADX is below 25 for more than 30 bars, price enters range conditions, and price patterns are often easier to identify. Price then moves up and down between resistance and support to find selling and buying interest, respectively. From low ADX conditions, price will eventually break out into a trend. In Figure 2, price moves from a low ADX price channel to an uptrend with strong ADX.

Source: TDAmeritrade Strategy Desk

Figure 2: When ADX is below 25, price enters a range. When ADX rises above 25, price tends to trend.

Source: TDAmeritrade Strategy Desk

Figure 3: Periods of low ADX lead to price patterns. This chart shows a cup and handle formation that starts an uptrend when ADX rises above 25.

The direction of the ADX line is important for reading trend strength. When the ADX line is rising, trend strength is increasing, and the price moves in the direction of the trend. When the line is falling, trend strength is decreasing, and the price enters a period of retracement or consolidation.

A common misperception is that a falling ADX line means the trend is reversing. A falling ADX line only means that the trend strength is weakening, but it usually does not mean the trend is reversing, unless there has been a price climax. As long as ADX is above 25, it is best to think of a falling ADX line as simply less strong (Figure 4).

Source: TDAmeritrade Strategy Desk

Figure 4: When ADX is below 25, the trend is weak. When ADX is above 25 and rising, the trend is strong. When ADX is above 25 and falling, the trend is less strong.

Trend Momentum

The series of ADX peaks are also a visual representation of overall trend momentum. ADX clearly indicates when the trend is gaining or losing momentum. Momentum is the velocity of price. A series of higher ADX peaks means trend momentum is increasing. A series of lower ADX peaks means trend momentum is decreasing. Any ADX peak above 25 is considered strong, even if it is a lower peak. In an uptrend, price can still rise on decreasing ADX momentum because overhead supply is eaten up as the trend progresses (Figure 5).

Source: TDAmeritrade Strategy Desk

Figure 5: ADX peaks are above 25 but getting smaller. The trend is losing momentum but the uptrend remains intact.

Knowing when trend momentum is increasing gives the trader confidence to let profits run instead of exiting before the trend has ended. However, a series of lower ADX peaks is a warning to watch price and manage risk. The best trading decisions are made on objective signals, not emotion.

ADX can also show momentum divergence. When price makes a higher high and ADX makes a lower high, there is negative divergence, or non-confirmation. In general, divergence is not a signal for a reversal, but rather a warning that trend momentum is changing. It may be appropriate to tighten the stop-loss or take partial profits.

Any time the trend changes character, it is time to assess and/or manage risk. Divergence can lead to trend continuation, consolidation, correction or reversal (Figure 6).

Source: TDAmeritrade Strategy Desk

Figure 6: Price makes a higher high while ADX makes a lower high. In this case, the negative divergence led to a trend reversal.

Strategic Use of ADX

Price is the single most important signal on a chart. Read price first, and then read ADX in the context of what price is doing. When any indicator is used, it should add something that price alone cannot easily tell us. For example, the best trends rise out of periods of price range consolidation. Breakouts from a range occur when there is a disagreement between the buyers and sellers on price, which tips the balance of supply and demand. Whether it is more supply than demand, or more demand than supply, it is the difference that creates price momentum.

Breakouts are not hard to spot, but they often fail to progress or end up being a trap. However, ADX tells you when breakouts are valid by showing when ADX is strong enough for price to trend after the breakout. When ADX rises from below 25 to above 25, price is strong enough to continue in the direction of the breakout.

ADX as a Range Finder

Conversely, it is often hard to see when price moves from trend to range conditions. ADX shows when the trend has weakened and is entering a period of range consolidation. Range conditions exist when ADX drops from above 25 to below 25. In a range, the trend is sideways, and there is general price agreement between the buyers and sellers. ADX will meander sideways under 25 until the balance of supply and demand changes again.

ADX gives great strategy signals when combined with price. First, use ADX to determine whether prices are trending or non-trending, and then choose the appropriate trading strategy for the condition. In trending conditions, entries are made on pullbacks and taken in the direction of the trend. In range conditions, trend-trading strategies are not appropriate. However, trades can be made on reversals at support (long) and resistance (short).

The best profits come from trading the strongest trends and avoiding range conditions. ADX not only identifies trending conditions, it helps the trader find the strongest trends to trade. The ability to quantify trend strength is a major edge for traders. ADX also identifies range conditions, so a trader won’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 trend-trading strategies. ADX also alerts the trader to changes in trend momentum, so risk management can be addressed. If you want the trend to be your friend, you’d better not let ADX become a stranger.

ADX Indicator

Average Directional Index

The Average Directional Index (ADX) is a trading strength indicator. It is used in technical analysis of the asset’s price to determine the strength of a trend regardless its direction. The best investment entry point is the beginning of a strong trend to increase profits and the ADX helps you identifying it.

What is the Average Directional Index (ADX)

The average directional index is employed to measure the trend strength. This consists of the graphical representation of three lines on a price chart. The ADX line, which is the middle line, receives a value from 0 to 99, This indicator identifies a strong trend every time it has a value equal or greater than 25, on the other hand, it discards a trend when its value is lower than 20. The average directional index uses a 14 days period for its calculation; however, it can be calculated using any 14 periods, even for binary options with minutes expiration, the ADX has proven to be an excellent strength trend indicator.

Understanding the average Directional Index (ADX)

  • The ADX is the graphical representation of three lines

a)ADX line is the middle line this is drawn on the average directional index of the 14 periods

b)DI+ line is the upper line, which is obtained by calculating the true range

c)DI- line in the lower line, which is obtained by calculating the true range

  • When the DI+ prices are above DI-, the trend is moving upward, prices are increasing and the ADX is measuring an uptrend strength.
  • When the DI- prices are above the DI+, the trend is moving downward, prices are decreasing and the ADX is measuring a downtrend strength.
  • True range is the greatest value among (Current high – current low), or (Current high – previous closing price).
  • The Directional movement is (the absolute value of DI+ minus The value of DI-) / divided (by the sum of DI+ + DI-)
  • ADX does not give a buying or selling signal. It identifies a strong trend, which is in place; you need to analyze the Di+ and DI- line crossover to identify properly the trend direction and possible market action.

Best Average Directional Index uses (ADX)

1.The average Directional Index is an excellent scanner to eliminate all the possible assets in trend and focus only on those with a strong trend and better net income potential.

2.The ADX can be used alone without any other oscillator or technical indicators on the price chart, since those may be confounding factors, The ADX will identify a strong trend, and then you will review if this is a downtrend or uptrend.

3.Each time the ADX is equal or greater to 30, is a clear signal for you to enter in the trade to maximize your potential investment revenue. Keep in mind this is the best sign you could ask for to trade.

4.Price is the most important data; you need to pay all your attention to it and the ADX value to identify correctly your best entry point.

Technical Classroom: How to use ADX Indicator for profitable trading

ADX is non-directional; it registers trend strength whether price is trending up or down.

Narnolia Financial Advisors

Technical Analysis Classroom: Part 21

Detecting a strong directional move is the most important skill for all traders to have. Trend chasing is the most popular technical method of profitable trading. But stock prices spend more time in consolidation and less time in trending move and so trend trading are prone to frequent drawdown. So before employing trend trading it is important to know whether the stock is in a trend or not.

The ADX indicator simply measures the strength of a trend and whether the price is in a trading or non-trading price movement. The ADX indicator by J. Welles Wilder is a wildly popular indicator for measuring strength of a trend. Unlike the RSI, ADX doesn’t determine whether the trend is bullish or bearish; but it measures the strength of the current trend.

‘Nifty can fall towards crucial support of 7,800-7,700’

Story in a chart: ‘Cup and Handle’ pattern in Coal India suggests buying opportunity

Story in a charts: Cup & Handle pattern suggests buying opportunity in India Cements

What is ADX Indicator?

The ADX (Average Directional Index) is a creation from technical analysis legend J. Welles Wilder which gives following important information.

• It informs a trader when the market is trending.
• It filters out anti trend trades to help trend chasing indicators from frequent whipsaws.

Figure .1.Illustration of ADX indicator

Construction of ADX Indicator

Using following three indicators together, chartists can determine direction as well as strength of the trend.

Figure .2.Construction of ADX indicator

As mentioned above the ADX is comprised of the following components:

1. Plus Directional Movement Index (DI+)
2. Minus Directional Movement Index (DI-)

ADX itself is the smoothed average of the difference of the DII+ and DII-. ADX cannot have a negative value.

Figure .3.Components of ADX Indicator

The above chart indicates the visualization of the ADX.
• Green Line = DI+
• Red Line = DI-

• Black Line = ADX

Interpretation of DI

While ADX provides information only about the strength of the trend, it is normally supplemented with Directional Index +DI and –DI for knowing the direction of the trend.

Their interpretation is as follows:
• When +DI is above -DI then trend is considered as an uptrend.
• When -DI is above +DI then trend is considered as a downwards.
• +DI is crossing over -DI signals trend reversal to bullish trend.

• -DI is crossing over +DI signals trend reversal to bearish trend.

Interpretation of ADX

• If the price is going UP, and the ADX indicator is also going UP, then we have the case for a bullish trend.
• The same is true if the price is going down and the ADX indicator is going UP. Then we have the case for a bearish trend.

• Value of ADX below 20 is called trading zone which implies non-trending market.

ADX strength scale

• If ADX is between 0 and 20 then the stock is in a trading range. It is likely just chopping around sideways. Avoid these for trend trading.
• Once ADX gets above 20 then start employing trending trade system. Big moves (up or down) tend to happen when ADX is right above this number.

Figure .4. Strength scale of ADX Indicator

Important concepts with ADX

Volatility & Volume: – The ADX is a valuable tool because it focuses on the trend and strength of the stocks. However extremely volatile stocks will not always adhere to ADX readings. Stocks that react favorably to the ADX should have high volume but not very high volatility

Divergence: – Unlike other indicators divergence in ADX does not predict change in trend. As long as the value stays above 20, the trend is intact.

Trading the Trend

• If the price is going UP, and the ADX indicator is also going UP & its value above 20 and +DI > – DI, it is a buy signal.
• If the price is going down and the ADX indicator is going UP & it is above 20 and -DI >+ DI, it is a sell signal.

Figure .5. Trading the Trend with ADX indicator

Trading the Ranges

When ADX is below 20, price enters a sideways or consolidation. When ADX rises above 20, price tends to trend. Low ADX is a usually a sign of accumulation or distribution.

When ADX is below 20, price enters range conditions, and price patterns are often easier to identify. Price then moves up and down between resistance and support to find selling and buying interest, respectively.

Figure .6. Trading the range with ADX indicator

This chart displays an ADX value that is below 20 and so the stock was in a tight range, which is perfect for range trading.

Weakness of ADX

• ADX is based on Moving Averages. Therefore it is very slow to react or in other words it is a lag indicator.
• ADX may not provide signals for slow moving or less volatile stocks.
• Crossover of +DI and -DI sometimes can happen too frequently, thereby giving many false signals.

• Unlike other indicators ADX cannot be used in isolation and should be used with other oscillators or indicators.

Conclusion

• The Average Directional Index (ADX), Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI) represent a group of directional movement indicators that form a trading system developed by Welles Wilder.
• ADX is non-directional; it registers trend strength whether price is trending up or down.

• When the +DMI is above the -DMI, prices are moving up, and ADX measures the strength of this uptrend. When the -DMI is above the +DMI, prices are moving down, and ADX measures the strength of this downtrend.

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