Welcome back!
Recall that we are still talking about indicators. Today, let us discuss Average Directional Movement Index
The Average Directional Movement Index, acronymically referred to as ADX is usually used to measure the overall strength of a trend in positive and negative direction. The trend can be either up or down, and this is shown by two accompanying indicators, the negative directional indicator (-DMI) and the positive directional indicator (+DMI). Therefore, the ADX commonly includes three separate lines. These are used to help assess whether a trade should be taken long or short, or if a trade should be taken at all.
The ADX is used by investors to determine trend strength, while -DMI and +DMI are used tp determine trend direction. This means that, when the ADX is above 25 this implies a strong trend, and a weak trend when the ADX is below 20. Crossovers of the -DI and +DI lines can also be used to generate trade signals and also to have an idea of potential trade exits.
For instance, if the +DMI line crosses above the -DMI line and the ADX is above 20, or ideally above 25, then that is a potential signal to buy. On the other hand, if the -DMI crosses above the +DMI, and the ADX is above 20 or 25, then that is an opportunity to enter a potential short trade.
Furthermore, to determine exiting current trades, if on a long position, exit trade when the -DMI crosses above the +DMI. However, when the ADX is below 20 the indicator is signaling that the price is trendless and that it might not be an ideal time to enter a trade.
The Bottom line,
- It is suggested that a strong trend is present when ADX is above 25 and no trend is present when below 20.
- When the ADX moves down from high values, then the trend may be ending. An additional research to determine if closing open positions is appropriate should be done.
- A declining ADX could be an indication that the market is becoming less directional, and the current trend is weakening.
- If after staying low for a lengthy time, the ADX rises by 4 or 5 units, (for example, from 15 to 20), it may be giving a signal to trade the current trend.
- If the ADX is rising then the market is showing a strengthening trend. The value of the ADX is proportional to the slope of the trend. The slope of the ADX line is proportional to the acceleration of the price movement (changing trend slope). If the trend is a constant slope then the ADX value tends to flatten out.
