Average Directional Index (ADX) Indicator
Today we will look at another uncommon indicator that isn’t really spoken of in the Forex trading community.
Remember the first day you were introduced to algebra in math class, and you were so confused? Okay, maybe not all of you, but for the majority of us it was the case. However, by the end of the term, you understood the concept.
Why? Because there were building blocks that helped us understand one aspect at a time. It wasn’t just all dumped on you at once (if it was, my apologies, you need to ask them for a refund).
Please don’t feel overwhelmed by the different indicators that you may never have used or even heard of before – we will go through their processes and what they are used for. So, let’s dive right into it.
Wilder, one of the pioneers of technical analysis, developed the Average Directional Index in the late 1970s. It was created for the commodity markets, but it is now widely used.
The ADX can be used with different approaches and in conjunction with other indicators.
What is the ADX indicator?
The ADX is designed to show the strength of a market trend, whether it is bullish or bearish. Originally, it did have faults, including the inability to tell if the market was in an uptrend or a downtrend.
Improvement was required, so the indicator was redeveloped to show the current market trend. This was achieved by incorporating two other values into the system.
The minus directional indicator (-D1): This indicator would indicate a downtrend (bearish market).
The plus directional indicator (+D1): This indicator would indicate an uptrend (bullish market).
These two indicators help understand where the market is and help anticipate where they could go (based on that trend’s strength). Now I know that many of you may be unimaginably confused right now, so let’s clear that up by looking at an example.
Average Directional Index (ADX) chart example
Source – QuickTrade
Look at the chart above, notice the ADX (Average Directional Index) created by Wilder. The blue line is the pure ADX indicator. It is the indicator that tells us the STRENGTH of the trend.
The red line is the minus directional indicator. This shows the presence of a BEARISH TREND.
The green line is the plus directional indicator. This shows the presence of a BULLISH TREND.
You will notice there is a 25 level on the indicator, this level shows which trend is most dominant at that point. So let’s put the pieces together.
The bearish trend is extremely strong because the ADX is at its highest, and the –D1 is above the 25 level. The -D1 ranges around that level until we see a huge drop, then the –D1 stays above the 25 level on the price chart.
This would work in the opposite direction for a bullish market. The ADX will remain constant if the markets are trending.
The beauty of this indicator is that you can also see if the markets are NOT TRENDING!! How? You might ask.
If the blue line (ADX) is close to 0 or approaching, then there is no trend because it does not represent strength in any direction. Rather it is showing a range-bound market. Stay away from those conditions and save your capital.