How to Use ADX (Average Directional Index)

The Average Directional Index, or ADX, is a tool for determining the comprehensive strength of a trend. It is based on the idea that trading, when the market is moving in the direction of a strong trend, increases the chances of profit and lowers the risk by a considerable margin. When trading, it can be helpful to measure the strength of a trend, irrespective of its direction.

Also regarding the matter of evaluating the strength of a trend, the Average Directional Index is a popular technical indicator for this purpose. The Average DirectionalIndex, or ADX for short, is another example of an oscillator.

ADX swing from 0 to 100, with readings below 20 indicating a weak trend and readings above 50 signaling a strong trend.

Calculation of ADX can be difficult, but in brief When the ADX is low, the harder the trend, the higher ADX goes it highlights periods when the price is usually going sideways or trading in a range. And when the ADX has risen above 50, this indicates that the price has taken up momentum in one direction.

This is not similar to Stochastic, ADX does not figure out whether the trend is bullish or bearish. Rather, it merely measures the strength of the current trend. Because of that, ADX is typically used to identify whether the market is ranging or starting a new trend.

ADX is considered a “directionless ” indicator. It is based on comparing the highs and lows of bars and does not use the close of the bar. So The harder the trend, the larger the reading irrespective of whether it is an uptrend or downtrend.

How to Use ADX

As a trader using indicator, always maintain your eyes on the 20 and 40 as the key levels when you're using ADX indicator, below is a little cheat sheet to guide you on how to Analyze the ADX values.

Take a look at these neat charts weve pulled up:

In this first example, ADX remained below 20 from late September until early December. As you can observe from the chart, EUR/CHF was stuck inside a range during that time.

Although starting in January, ADX started to jumpabove 50, indicating that a strong trend could be waiting in the wings. Also would you look at that! EUR/CHF broke below the bottom of the range and went on a strong downtrend. Huhh, that would be around 400 pips in the bag. It is time to bag!

Now, lets look at this next example:

Similar to our first example, ADX hovered down 20 for quite a while. EUR/CHF was also ranging at that time. Quickly enough, ADX rose above 50 and EUR/CHF broke above the top of its range.

A powerful uptrend took place. That would be 300 pips, signed, sealed, and delivered!, looks quite simple right？

The only failure we can even mention which can be experienced when using ADX is that it doesn‘t exactly tell you whether it’s a buy or a sell. All it does is to tell you whether it would be okay to jump in an ongoing trend or otherwise.

The moment ADX begins dropping below 50 again, it could mean that the uptrend or downtrend is starting to weaken and that it might be a good time to lock in profits.

How to Trade Using ADX

One way to trade using ADX is to wait for breakouts first before making your mind to go long or short. ADX can be used as confirmation whether the pair could possibly continue in its current trend or not.

Additional way is to merge ADX with another indicator, particularly one that identifies whether the pair is headed downwards or upwards. ADX can also be used to clarify when one should close a trade early.

For instance, when ADX starts to slide below 50, it indicates that the current trend is losing steam.

From then on, the pair could possibly move sideways, so you might want to lock in those pips before that happens.

As the saying goes, “The trend is your friend.” Until it stabs you in the back.

Let's say “ Until it reverses.” instead

By the time you think a trend is changing and you need to decide whether to stick to this “friend” or cut ties, consider trying the ADX to confirm the trends strength.