Would you like to be able to tell when a currency pair is trending or not? If you are serious about forex, your answer should be yes – that’s why you need to know about the average directional index (ADX) indicator.
Analyzing The ADX Indicator
The ADX indicator is one of the trend-following technical indicators that were developed and introduced into the markets by J. Welles Wilder in 1978. It is technically classified as an oscillator with values ranging from 0 to 100.
The ADX indicator is used by forex traders for three main functions: 1. identifying a trend or trading range, 2. measuring the strength of a trend, and 3. as a filter for different trading strategies.
EURUSD Chart with 14 period ADX chart.
The ADX indicator typically appears as a chart below the currency pair’s chart and consists of three lines of different colors. In the chart above, the blue line represents that ADX line, while the green line represents the positive directional indicator (+DI) and the red line is the negative directional indicator (-DI). The two DI lines largely provide directional information as well as measuring the strength of a trend.
The values on the ADX indicator are absolute values, which means that they only feature positive values for both the negative and positive trends. The ADX is non-directional and rises when a strong downward trend or upward trend has begun.
Measuring The Strength Of The Trend
The ADX indicator measures whether a currency pair is in a strong trend or whether it is simply trading sideways. The ADX line revolves around a scale that starts from 0 up to 100 with levels below 25 indicating that a currency pair is trading sideways and levels above 25 indicating that a currency pair is trending in one direction or another.
Traders can choose different values for the ADX line in the MT4 platform, which could be used as an indicator that a strong trend has begun. Remember the difference between choosing 20, 25 or 30 as the start of a strong trend is that the lower values will get you into trades much sooner and will get you out of trades much later.
| ADX Line Value | Trend Strength |
| 0-25 | Absent Or Weak Trend |
| 25-50 | Strong Trend |
| 50-75 | Very Strong Trend |
| 75-100 | Extremely Strong Trend |
The ADX indicator can measure changes in market sentiment based on the above values, which track the changes in trend on a forex chart. The ADX line values are a direct measure of the strength of the trend displayed on forex charts.
The ADX is not a leading directional indicator and as such should not be used as a complete trading strategy on its own. However, you can combine signals of a strong trend from the ADX indicator with other indicators such as the moving averages and the stochastic indicator to create a highly effective trading strategy.
Combining the moving average crossover trading strategy with the ADX indicator allows a trader to filter out all the false moving average crossover signals that are not supported by a strong trend. However, executing the trade signals that are supported by the ADX line being above 25 or 30 is a better trading strategy, which allows traders to ride very strong forex trends.
The DI Line Crossover Signals
While not designed to show the direction of trends before they occur, traders can use the crossover between the +DI and -DI lines to confirm trend direction for trend signals generated by the ADX line. For example, when the +DI line crosses above the -DI line, it confirms that an uptrend is underway. This is because such a crossover occurs as a result of the price moving higher as evidenced by higher highs and higher lows on the chart candles. Whenever the -DI line crosses above the +DI line a downward trend is usually confirmed. This is because such a crossover indicates that the price of the currency pair has been heading lower as evidenced by lower highs and lows on the candles within a given chart.
You should remember that as a trend-following indicator, the ADX is a lagging indicator and cannot predict the future direction of trends. You will want to use other indicators to help you determine the likely direction of the trend as you place your trade.
Conclusion
As with most indicators, the ADX indicator is not 100 percent reliable. It can sometimes generate false signals and traders should always limit their risk exposure when using this indicator. Proper position sizing is also crucial for traders using this indicator who would like to enter into low-risk high-reward trade setups. One of the best ways to use the ADX indicator is to use it as a filter for trade signals generated by other indicators, such as the moving average cross overs and the MACD indicator.
