Hello, dear friends. By now, it's common knowledge that
Forex, which operates 5 days a week and 24 hours a day, is the world's largest
financial market. Extraordinarily large, even astronomically large sums of
money are traded here. When I say 'astronomical,' I'm not exaggerating. What I
consider an unreachable sum becomes astronomical. Do you think a market with a
daily trading volume of $5.5 trillion is not astronomical? If not, let's see if
you can accumulate that much money in your bank account. It's such a extra
large global market that traders from all over the world, from the Americas to
remote islands in the oceans, participate. While participants' locations in the
financial markets may vary, their goals are the same: to make a profit. To
achieve this, we need to understand the rules of the market. The first tool
often used is technical analysis, and one of the most widely known tools in
technical analysis is technical indicators. In this article, as we explore the
Average Directional Movement Index/Wilder's DMI (ADX) indicator, we will cover
the following topics:
- What is the ADX indicator?
- How does the ADX indicator work?
- How to interpret the ADX indicator?
- Other technical indicators that can be used in conjunction with the ADX indicator.
What is the ADX indicator?
The Average Directional Movement Index (ADX), is one of the
technical analysis indicators developed by J. Welles Wilder. ADX stands for
Average Directional Movement Index. ADX is used to measure the strength and
direction of a trend in financial markets and it takes a value between 0 and
100. It is particularly useful for determining whether a trend is gaining or
losing strength. If the ADX value is below 20, it indicates a weak trend. If
the ADX value is above 40, it suggests a strong trend. This indicator provides
exceptional advantages to those who want to gain insights into the strength of
a trend in various financial instruments, including stocks, currency pairs,
commodities, and more.
How does the ADX indicator work?
ADX operates by using three separate trend lines to measure
the direction and strength of price movements on a currency pair or any other
asset. These are as follows:
1) +DI or +DMI (Positive Directional Movement Indicator). The green line on the chart, also known as the positive trend line. This line
measures the strength of upward price movements. +DI is calculated by averaging
upward price movements over a specific period.
2) -DI or -DMI (Negative Directional Movement Indicator). The pink line on the chart, also referred to as the negative trend line. This
line measures the strength of downward price movements. -DI is calculated by
averaging downward price movements over a specific period.
3) ADX Line (Average Directional Index). The purple line
on the chart. ADX is calculated by taking the absolute value of the difference
between +DI and -DI lines. This line represents the strength of the trend. ADX
values typically range between 0 and 100. Higher ADX values indicate a stronger
trend.
+DI measures the tendency of prices to move upward, while
-DI measures the tendency of prices to move downward. ADX is used to gauge the
strength of the +DI and -DI lines. The ADX line takes the average of +DI and
-DI lines. The higher the ADX line, the stronger the trend.
How to interpret the ADX indicator?
Unlike other technical indicators, the ADX indicator doesn't
primarily generate buy or sell signals. Instead, it assesses the presence of a
trend and how strong it is, usually ranging between 0 and 100. Low ADX values
(usually below 20) indicate a sideways market or a weak trend. In such cases,
it suggests that a trend isn't progressing strongly, the market is indecisive,
or there may not be a clear trend in the market. High ADX values (typically
around 40-50 and above) indicate the presence of a strong trend. This means
that a trend is making a strong move or a new trend has started.
If +DI is higher than -DI, it indicates that the upward
movement is strong, while conversely, if -DI is higher than +DI, it suggests
that the downward movement is strong. In addition to this, as the ADX value
rises, it signifies an increase in the strength of the trend. As trend
followers, we can see that the trend is gaining strength, and it makes more
sense to follow that trend. When the ADX value decreases, it indicates a
decrease in the strength of the trend. In such cases, the market may be moving
sideways or the trend may be weakening. While ADX is mostly used to measure the
strength of a trend, it should not be used as a standalone tool for trend
following. Using this indicator in combination with other technical indicators
can lead to more exact results.
Other technical indicators that can be used in conjunction
with the ADX indicator.
We can develop stronger and more robust trading strategies
by combining the ADX indicator with other technical analysis indicators and
methods. Here are some technical indicators that can be used in conjunction
with ADX:
Moving Averages. Combining ADX with moving averages
strengthens your trend-following strategies. Especially during periods when ADX
is rising, you can use moving average crossovers to generate buy and sell
signals. For example, if +DI is higher than -DI, ADX is 20 or higher, and the
price crosses above the moving averages, it could be a signal to go long.
Conversely, if -DI is higher than +DI, ADX is 20 or higher, and the price
crosses below the moving averages, it could be a signal to go short. Look at the
example on the EUR/CHF chart:
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| Trading via ADX indicator in the EUR/CHF chart |
Volume Indicators. Volume indicators display volume
information that can influence price movements. By using volume indicators
alongside the ADX indicator, you can make more accurate predictions about
trends.
We can use ADX alongside MACD, RSI, Stochastic Oscillator,
and other technical indicators. This means that different indicators can offer
different perspectives and can generate stronger signals when combined. For
example, if ADX is high, RSI is in overbought territory, and the price breaks
through a resistance level, it can be a sell signal. We can use MACD to
determine the strength and direction of the trend, and Stochastic Oscillator
and RSI to identify trend extremes.
Keep in mind. When trading in financial markets, we
should not rely on a single indicator alone and must always add other technical
tools to confirm. We should always carefully evaluate market conditions and
risks, and we should not forget that indicators can be misleading and may not
always produce accurate signals. Successful trading!