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ADX: determing the strength of price movement

The ADX (average directional index) is an indicator that shows you how strong a trend is.

The ADX gives you a reading that generally ranges between 0 and 50. The higher the reading, the stronger the trend. The lower the reading, the weaker the trend.

The ADX is very useful as a confirmation tool when you want to trade in a trending market, but it will not give you reliable buy or sell signals on its own.

The ADX indicator measures how strong a trend is. It does not provide buy or sell signals, so it is best used with other indicators.

Using ADX to measure the strength of a trend

The ADX consists of three lines, which all measure price action in slightly different ways:

  • The ADX line
  • The DI+ line
  • The DI- line

The chart below shows what the indicator looks like:

  1. DI+ line
  2. DI- line
  3. Main ADX line

The straight red line passing horizontally through the middle of the indicator box marks the 25 level.

If the blue ADX line moves below this 25 level it indicates a ranging market or a trend that is too weak to trade. If it moves above the 25 level it indicates a strong trend has now been established.

A reading of between 30 and 50 signals a strong trend.

If the ADX line reaches as high as 50, however, the trend is considered at its peak and no new trades should be attempted, as the market very often reverses from that point.

A reading between 30 and 50 signals an extremely strong trend that has a high probability of generating a profit. A reading over 50 means the trend is at its peak and no new trades should be attempted.

The DI+ and DI- confirm whether a trend is up or down

The main ADX line displays the smoothed average of movements in the price. As already explained, a reading higher than 25 shows you that a trend has been established.

The DI+ and DI- lines meanwhile interact with each other to confirm whether that trend is up or down.

When the DI+ line rises above the DI- line, the trend direction is said to be up. When the DI+ line falls below the DI- line, the trend direction is said to be down.

Take a look at the chart below:

  1. DI+ line crosses above DI- line, indicating any trend is up
  2. ADX is above 25, confirming trend
  3. Price is in an uptrend

As you can see, the dotted green DI+ line moves above the DI- line, shown at (1), signalling the trend direction is up. The blue ADX line (2) is above the 25 level, meaning that the price is now trending.

Changing the ADX periods

The ADX calculates its reading from a certain number of trading periods (or candles) on the chart. The standard setting is 14 periods, but this can be modified to suit your own trading style.

As a guide, traders generally stick to the range of 7 periods to 30 periods when adjusting the settings.

The chart below shows how different period settings affect the ADX readings:

In the chart above, the ADX is set to 28, shown in the top left corner of the indicator box.

The standard setting for the ADX is 14 periods and can be modified to suit your trading style.

 

Using a relatively high setting ilke this smooths out the average price action shown by the ADX line over a longer time frame.

This results in more reliable trend readings. However, it also means that recognising them takes longer. You can therefore miss a big portion of any price trend by the time the indicator alerts you to it.

Using lower settings will result in more trends being detected earlier, but some of those "trends" can be false.

In the chart below, the indicator is set to 7, making the main ADX line appear choppier:

While a lower period setting results in more trends being detected earlier, it raises the likelihood of false signals.

Settings do not change DI+ and DI- readings

Take note that changing the ADX settings will usually have only a negligible effect on the DI+ and DI- lines.

On both of the charts above, for example, you can see that the red DI- line moves above the DI+ line. They therefore indicate a downward trend regardless of whether the indicator is set to periods of 28 or 7.

If you do change the settings for the ADX indicator, always check whether your changes are improving or worsening your trading results. You will learn which settings suit you best through trial and error.

 

Summary

In this lesson, you have learned ...

  • ... the ADX is primarily a trend strength indicator.
  • ... it is a useful confirmation tool but it does not provide buy or sell signals.
  • ... it consists of three lines – the DI+, DI- and ADX lines – which measure price action in a slightly different way.
  • ... it provides a reading that generally ranges between 0 and 50.
  • ... a reading below 25 indicates a weak trend.
  • ... a reading of above 25 signals a strong trend.
  • ... a reading of between 30 and 50 signals an extremely strong trend.
  • ... a reading of over 50 signals that a trend is at its peak and could soon reverse.
  • ... the standard setting for the ADX is 14 periods and traders usually opt for a setting of between 7 and 30 periods.
  • ... a higher setting will smooth price action and provide more reliable signals but might alert you to trends too slowly.
  • ... a lower setting will result in more trends being detected earlier but can also provide false signals.