As technical indicators go, the ADX often gets lost in the weeds compared to the more popular MACD, RSI and Stochastics. However, if used properly the ADX can be a big help in trading the Forex profitably. The Average Directional Index was developed by Welles Wilder, a prolific researcher and writer on the financial markets. Investopedia describes the ADX as an indicator that is “used to determine when price is trending strongly”. There are three components to the ADX: the DI+ line tells us when there is a positive, upward trend prevalent in a given market; conversely the DI- line tells us when there is a negative, downward trend. The last component is the ADX line itself which tells us the strength of the trend. I like to make the DI+ green and the DI- red..since on my charts green bars show upward moves and red bars show downward moves.
The ADX is used like this: when the green (DI+) line crosses above the red (DI-) line, then a positive, upward trend is gaining dominance in the market and you can expect prices to rise. When red crosses above green, just the opposite happens, a negative/downward trend is coming into play. Now, if the ADX line is rising as well, that tells you the strength of that move is increasing. If the ADX registers a reading of 20 or below, we say there is no trend in place. A reading between 20 and 25 suggests a weak trend. When the ADX is above 25 a strong trend -up or down- is present. Remember, the ADX line doesn’t tell which way the market is moving, only the strength of the trend. Look to see whether the green or red line is on top to get the direction. That’s it in a nutshell.
There are other considerations such as which time frame is best to use…which currency works best with this, what are the optimal settings, what are the best times to trade…and more. Do you need to keep your eye on the chart all day? There are good answers to all this which I will address in subsequent articles.
John Houston has been trading the Forex for over five years. He’s studied under some of the best brains in the business focusing on Elliott Wave, fundamental and technical indicators and various trading systems. John has used several Expert Advisors and is proficient with MT4. He is in the course of developing an ebook on using the ADX to trade the Forex profitably. Watch his blog for updates.