Indicator Toolbox – ADX

The last ten articles have been entitled Analysis Toolbox and we discussed the various market cycles including trends and continuations. This next part of the The Trader’s Indicator Series focuses on the Indicator Toolbox, as we will discuss various indicators that are found on most trading platforms. We will discuss the indicator in the context of the chosen market, and if it resonates with you, please continue to do your own analysis with it. Trading successfully is all about feeling comfortable with a methodology and using that system repeatedly even when boredom sets in. I will be discussing indicators in alphabetical order that can be found on the MotiveWave platform. (for a free 2-week trial CLICK HERE)

In the last series, called The Trader’s Pendulum, we took you through the 10 Habits, all aimed to support a successful trader. Your mission in developing these habits is to get out of the Technical Trader’s Trap and transform into an Entrepreneurial Trader so that you can start being accountable to your trading. We invited you to take action and begin your journey by completing the Trader’s Scorecard (www.fxtradersedge.com/scorecard) and to get down to business by arranging a free coaching session. In this Indicator Series, we talk about the mechanics of trading.

ADX is an indicator of trend strength in a series of prices. It is composed of two other indicators, the positive directional movement indicator (+DMI) and the negative directional movement indicator (-DMI). The ADX combines and smoothes these indicators. Developed by J. Welles Wilder in 1978.

ADX

PARAMETERS

ADX, -DMI and +DMI are presented as directional indicators that can be used as a trading system as developed by Welles Wilder. The ADX measures trend strength, whether bullish or bearish. -DMI and +DMI define the direction of the current trend and by combining all three components, one gets a read on trend direction and trend strength.

-DMI and +DMI are calculated by comparing the difference between two consecutive lows and the difference between two consecutive highs. A negative value is a zero entry.

Directional Movement is negative (-DMI):

Previous low – current low > current high – previous high

Directional Movement is positive (+DMI):

Current high – previous high > previous low – current low

The ADX default setting is 14 bars, although other time periods can be used as well. ADX is plotted below the price chart and the values range from 0 to 100. ADX values help traders confirm the trend and even better, to identify strongly trending markets. A value greater than 50 signifies a very strong trend and the closer the value is to 100, the stronger the trend. A value between 0 to 20 signifies a weak or non-existent trend. A value between 25 to 50 indicates a strong trend. Traders look for readings above 25 to confirm getting into the trend, whether bullish or bearish and avoid trend trades with readings below 20.

USING THE TOOL

Traders use the ADX indicators to recognize trends, corrections and reversals. The indicator tells you whether the market is trending and how strong the trend is. When the ADX line is steep and rising, the trend is strong and strength is increasing. As soon as the ADX line reverses and falls, it just means that the trend strength is weakening but it doesn’t say anything about a trend reversal.

The ADX also shows divergence which can be a sign of a weakening trend. When price makes a higher high and the ADX makes a lower high, this is called divergence with declining momentum. Traders can get forewarned about an imminent market reversal. The ADX also confirms retracements when price is moving higher and the ADX retraces with price.

EXAMPLE

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In the USD/CAD 4-Hour chart example above, one sees a clean upward swing move followed by a downward swing move. For the uptrend move, the +DMI is above the -DMI indicating an uptrend with prices moving higher. Notice when the red -DMI crosses above the green +DMI, signaling a change in trend from up to down, and when the green crosses above the red, signaling a change in trend from down to up. In between the dotted vertical lines, the +DMI is above the -DMI and the market is in an uptrend. The dotted lines signal a change in trend when the DMI’s cross one another.

Using the ADX suite of indicators provides a decent determination of trend direction and strength and when used in combination with candlestick and price patterns, can form the basis of a trading strategy to trade the various market cycles.

This indicator is one of the more popular indicators in the traders’ toolbox.

See you next week for another “A” indicator!

If your mission is to become a trader or investor who stays out of the Technical Trader’s Trap, then take the leap to grow into an entrepreneurial trader.

I created the FX Trader’s EDGE Coaching Program modelled after the “10 Habits of Successful Traders”, which is the title of my newly published book by Wiley.

The Trader’s Pendulum: The 10 Habits of Highly Successful Traders.  Copyright (c) 2015 by Jody Samuels.  This book and ebook is available at all bookstores, online booksellers, and from the Wiley web site at www.wiley.com.

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