The Average Directional Movement Index (ADX) is a technical indicator used on exchanges, including Forex, primarily to determine the presence of a trend. Like the ATR indicator, it was created by Wells Wilder and described in detail in his book “New Concepts in Technical Trading Systems”.
The ATR indicator is standard for the MetaTrader 4 trading platform.
Trading Signals from the ADX Indicator
Wells Wilder suggested using the components of the ADX indicator as a ready-made trading strategy. To determine a trading signal, it is necessary to track the crossing of the 14-period +DI and 14-period -DI:
- Bullish signal occurs when +DI rises above -DI;
- Bearish signal occurs when +DI falls below -DI.
For convenience, the +DI and -DI indicators are plotted on top of each other.
Extreme Point of the ADX Indicator
Since the ADX is a trend-following indicator, false signals from it are not uncommon. To reduce their number, Wells Wilder added the “extreme point rule” to his strategy. The principle is simple: when you detect a crossing of +DI and -DI, mark the “extreme point.” For a bullish signal, this point is the highest price of the day of the crossing. For a bearish signal, it is the lowest price of the day of the crossing.
This extreme point is used by traders as an entry level limit. After a bullish signal (+DI above -DI), wait for the price chart to move above the established extreme point before entering a buy trade. If the price does not exceed the extreme point, it’s better to stay out of the market. Similar rules apply for a bearish signal, but in the opposite direction.
Formula for Calculating the ADX Indicator
ADX = SUM[(+DI – (-DI)) / (+DI + (-DI)), N] / N,
where N is the number of periods used for calculation.
FAQ
What is the ADX indicator?
The ADX indicator is a technical tool used to measure the strength of a trend in financial markets.
How do I interpret ADX signals?
ADX signals are interpreted by tracking the crossing of +DI and -DI lines. A bullish signal occurs when +DI crosses above -DI, while a bearish signal happens when +DI crosses below -DI.
Why is the ADX important for traders?
The ADX helps traders assess whether a market is trending or ranging, which can influence their trading decisions and strategies.
