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ADX Indicator Trading Strategy
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The secondary trend can be seen on the daily or weekly charts and finally, the minor trends can be seen on the lower time frame charts such as the minute or hourly time frame. As we have described earlier, The Average Direction Index is a technical indicator that gauges both the strength and direction of a trend in a security being analyzed. The ADX trend indicator is commonly used to compliment other technical methods or indicators to build a trend following trading system. The ADX line shows the strength of the trend. When you combine the information from all three components, you can derive a picture of the existing market condition.
The ADX indicator is depicted in the sub-window of the price chart similar to where technical oscillators are plotted. There are many different techniques to build a robust ADX trading strategy, and we will discuss a few in this lesson later on. As shown in figure 1, you can see that the forex adx indicator has the three lines. The dotted black line is the ADX line and this depicts the strength of the trend. The adx trading rules are simple. Now that we have learned the basic elements of the average directional index indicator, we will now turn our focus on how the ADX DMI indicator is actually calculated.
Understanding how an indicator is calculated and the values plotted is important in building up to knowing how to actually use an indicator most effectively. Still, it is important to know what factors and values are considered by the ADX indicator when it fires off a signal. The -DI or negative is calculated by subtracting the previous low against the current low and this should be greater than the current high subtracted from the prior high. This is the input parameter for the ADX period.
The typical default value of the ADX indicator is 14 period. So, this 14 period becomes the smoothing period for the ADX line.
When the ADX line crosses above the 20 or 25 thresholds from below, this suggest that the market is transitioning from a trendless market condition to a trending market condition. And so long as the ADX line stays above this level, it is an indication that the market is in a trending environment. In Figure 2, we can see two areas where the trend strength indicator shows the strongest bearish and bullish short term trends. Figure 2: Determining trend strength using the ADX indicator.
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In Figure 2, the first region marked by the red area shows the bearish trend in play. The ADX line on the other hand rises sharply, indicating that the downtrend is strong. The ADX line initially bounces off 20 — 25 and then rises strongly.
How to Use ADX to Identify Forex Trends
This suggests the uptrend in the price. The strength of the trend is also depicted by the rising ADX line which is above the 20 — 25 level and moves steadily higher. In figure 3, the chart illustrates an example of the bullish and the bearish trend in the market. This bearish trend is also depicted by the crossover of the DI lines. In the second instance, a bullish trend is shown. These crossovers can be viewed in the same light as you would a dual moving average crossover signal.