The average directional index indicator: what it is and how to use it

For example, if the +DI line crosses above the -DI 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 -DI crosses above the +DI, and the ADX is above 20 or 25, then that is an opportunity to enter a potential short trade. Cory Mitchell, CMT is the founder of TradeThatSwing.com. He has been a professional day and swing trader since 2005.

A bearish crossover is the opposite of a bullish crossover. This happens when the negative directional indicator line cross over the positive directional indicator line. This indicates that the negative price change is higher than the positive price change. Here, too, checking if the market is trending is important. Calculations for the ADX are based on a moving average of price fluctuations over a specific period. The ADX combines two other indicators developed by Wilder, the positive directional indicator (+DI) and the negative directional indicator (-DI).

Average directional movement index

When trading this combination, look for when the Parabolic SAR prints at least three consecutive parabolas in the trend’s direction. On the other hand, if three successive parabolas go against the trend, you have an early exit signal. Applying this strategy requires you to place a buy order when the price is going down, the ADX is above 25, and the RSI is below 30. On the other hand, if the price is ranging high, the ADX is above 25, and the RSI is above 70, you can consider the market overbought and open a short position. If the +DI crosses from below the –DI and the ADX are above 25, expect a bullish price movement. On the other hand, when the –DI crosses from below the +DI and the ADX is above 25, you can consider it a good moment to go short.

But it still confirms that this reversal isn’t a correction but a major bullish trend transitioning into a bearish one. If -DI is above, it’s a downtrend and its primary movement may end soon. If +DI is above, it’s an uptrend and its primary movement may end soon. In the first scenario, the downtrend movement ended as soon as the index reached the 50th level.

Average Directional Index (ADX): Definition and Formula

Rather, it merely measures the strength of the current trend. When trading, it can be helpful to gauge the strength of a trend, regardless of its direction. DMI assists in determining if a security is trending and attempts to measure the strength of the trend. When the ADX turns down from high values, then the trend may be ending.

• The conservative option is based on the first signal, as shown in the example, or by a point stop.
• It would have been prudent to ignore bearish signals with a bullish continuation pattern taking shape.
• EUR/CHF broke below the bottom of the range and went on a strong downtrend.

ADX can also be used to determine when one should close a trade early. One way to trade using ADX is to wait for breakouts first before deciding to go long or short. Find the approximate amount of currency units to buy or sell so you can control your maximum risk per position.

The second signal occurs when the green candles break out of the resistance level built on the significant downtrend extremes. As soon as ADX rises above 20%, open a short Forex trading position as -DI is at the top. The stop-out level is the previous candle high, the yellow line. It’s reasonable to set a trailing stop instead of the regular stop. When the period decreases, it speeds up the indicator movement and increases the number of false signals. In the Levels tab, add fixed horizontal levels to visually limit the main range of movement of the indicator and overbought/oversold zones.

You can see that it mirrors the green line but in the opposite direction, showing the strength of the downtrend. The green line is the Plus Directional Movement Index (+DM ). It gauges the strength of the upwards price movements in the graph.

While observing the open trade, I simultaneously monitor the situation on an hourly interval. After 30 minutes, the oscillator rose above 20% on an hourly interval. The maximum distance between + DI and -DI indicates an extremely strong trend. The greater the distance between + DI and -DI, ​​the more likely we’ll see a price reversal or temporary range consolidation soon.

You can either close your position entirely or use trailing stops and capture a part of the profits. Also, make sure to look at whether the ADX line marks consecutive higher highs or lower highs. In the first case, it means the trend momentum is increasing.

The Bottom Line: Finding Friendly Trends

Charles is a nationally recognized capital markets specialist and educator with over 30 years of experience developing in-depth training programs for burgeoning financial professionals. Charles has taught at a number of institutions including Goldman Sachs, Morgan Stanley, Societe Generale, and many more. Due to the fact that the lirunex review includes multiple lines, the indicator requires a sequence of calculations, which are laid out below.

The Average Directional Index is in turn derived from the smoothed averages of the difference between +DI and -DI; it measures the strength of the trend over time. Like any indicator, the ADX should be combined with price analysis and potentially other indicators to help filter signals and control risk. When a strong trend is changed by an opposite strong trend, ADX indicator is totally useless.

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Wilder suggests that the minimum ADX level for entry should be 25, but many traders however use 20 as the key level as it produces more possible signals. When entering a long position, Wilder suggests that a stop-loss should be placed on the low of the signal day, depending on what time-frame you are trading. It would also be wise to actually place the protective stop several pips below the support, so that random noise or an attempt to break the days low doesnt trigger it.

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+DI and -DI crossovers are quite frequent and chartists need to filter these signals with complementary analysis. Setting an ADX requirement will reduce signals, but this uber-smoothed indicator tends to filter as many good signals as bad. In global prime broker other words, chartists might consider moving ADX to the back burner and focusing on the Directional Movement Indicators (+DI and -DI) to generate signals. These crossover signals will be similar to those generated using momentum oscillators.

How to look for trend momentum

Note that, although it might seem a bit confusing, the good thing is you won’t have to go through it every time you apply the indicator. The steps below are just for your reference and to help you understand the xm broker indicator’s mechanics. When trading, you will simply be leaving the computer to do the job. In fact, Wilder’s work is so essential that today many of his concepts are at the core of all charting software.