The ADX indicator (Average Directional Index) is used to determine whether a market is in a strong trend or in a sideways range. It helps traders identify the strength and direction of a trend on monthly, weekly, or daily charts. The system works independently with a low probability of success, not exceeding 60%.
The System Consists of Three Lines:
- A line constructed based on the maximum values of candles for +DMI;
- A line constructed based on the minimum values of candles for -DMI;
- ADX line.
In the author’s trading system, only the ADX line is used.
ADX Calculation Formula
Positive and negative directional movement (+DMj and -DMj) are calculated:
If Highj (current candle’s high) > Highj-1 (previous candle’s high), then +DMj = Highj – Highj-1, otherwise +DMj = 0; if Lowj (current candle’s low) -DMj, then -DMj = 0; if -DMj > +DMj, then +DMj = 0; if +DMj = -DMj, then both +DMj and -DMj = 0.
The true range (TRj) is determined:
TR = the maximum of the absolute values of three values:
1. |High – Low|,
2. |High – Close j-1|,
3. |Low – Close j-1|,
where Close j-1 is the closing price of the previous period.
The positive and negative directional indicators (+DIj and -DIj) are calculated:
+DIj = Exponential Moving Averagej (+SDI, N);
-DIj = Exponential Moving Averagej (-SDI, N), where if TRj ≠ 0, then +SDIj = +DMj / TRj; -SDIj = -DMj / TRj; if TRj = 0, then +SDIj = 0, -SDIj = 0.
The average directional movement (ADXj) is determined:
ADXj = Exponential Moving Averagej (DX, N), where DXj is calculated using the formula:
When there is a trend, ADX should rise and be equal to 20 or higher. When the ADX line is below 20, additional criteria for identifying a trend include:
- Three consecutive increases in ADX above 15;
- ADX crossing the 20% threshold from below;
- The difference between the last minimum ADX value and the value on the last closed candle is more than 4%.
Trading Signals
Intersection of +DI and -DI lines when ADX is rising is a entry point.
- The +DI line, moving upward, crosses the -DI line, moving downward, from below. With rising ADX, this intersection is a buy entry point. It is advisable to wait for the next candle after the DI lines cross to confirm the signal by having the price close above the high of the last closed candle.
- The -DI line, moving upward, crosses the +DI line, moving downward, from below. With rising ADX, this intersection is a sell entry point. It is advisable to wait for the next candle after the DI lines cross to confirm the signal by having the price close below the low of the last closed candle.
- Further upward movement of ADX from values below 15 provides another intersection of the ADX line with the descending +DI or -DI line. This intersection of ADX with the +DI or -DI line confirms the existence of a trend and provides a good point to increase the position.
Warning: Sometimes, at this moment, the market is in a state of overbought or oversold conditions, so it may make sense to wait for a pullback or consolidation before entering the trade.
ADX provides important information about the market’s condition, but without fine-tuning to the market’s state, the system is doomed to fail. ADX can help identify whether a trend exists. It also informs about the beginning or end of a trend. The end of the most powerful trend impulse is usually marked on ADX. It also indicates the development of a correction, reversal, or continuation of the movement.
ADXR Indicator
The ADXR indicator consists of two lines: fast ADX and slow ADXR.
ADXR Calculation Formula
The slow ADXR line is calculated by adding two ADX values (the current value and the value n periods ago). The resulting sum is divided by two. This additional smoothing makes ADXR slightly less sensitive than ADX.
ADXRi = (ADXi + ADX(i – n)) / 2, where n is the ADXR period.
The classical interpretation is the same as for ADX: the higher the value, the stronger the trend. ADXR is a smoothed version of ADX and can be used similarly to ADX.
In the MetaTrader4 terminal, the ADXR indicator is built as follows:
A) On the daily chart, the ADX indicator has the following parameters: period 7 or 8; apply to ‘Close’; style ‘White’; all lines thin; colors of ‘+DI’, ‘-DI’ background color of the screen; level 20%.
B) On the same chart, the ADXR indicator is plotted with the following parameters: period 13 or 16; apply to ‘Close’; style ‘Blue’; all lines thin; colors of ‘+DI’, ‘-DI’ background color of the screen; no levels.
This results in two lines in one area: fast (white) and slow (blue). The ADXR indicator is ready.
Interpretation of the Entire Indicator for This Trading System
The indicator does not indicate the direction of the trend. It shows which indicators have a higher probability of correctly determining the color of the next candle:
- If both lines are moving upward, use trend indicators, and the candle body is calculated based on MACD, moving averages, and volume;
- If both lines are moving downward or in different directions, use oscillator-type indicators, and the candle body is calculated based on CCI, RSI, and volume.
Working with Other Indicators
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FAQ
What is the ADX indicator used for?
The ADX indicator helps determine if a market is in a strong trend or sideways range, showing the strength of a trend on various timeframes.
How is the ADX calculated?
ADX is calculated using positive and negative directional movement, true range, and exponential moving averages to measure trend strength.
When should traders use ADX signals?
ADX signals are useful when the ADX line is rising above 20, indicating a strong trend. Traders should confirm DI line crossovers with price action before entering trades.
