TC 3 : Average Directional Index – ADX

stock-market-strategy

Average Directional Index – ADX

http://www.stock-market-strategy.com/education/technical-analysis/average-directional-index-adx/

The Average Directional Index was created by J. Welles Wilder with the intention of having an objective measurement of the strength of a trend. This is an important feature as we often trade trending markets different from sideways market. For example, overbought RSI in an up trending market is not a signal to go short whereas overbought relative strength index-RSI in a trading range is much closer to being a signal. The ADX is far from perfect. It has the same issue like other market indicators of lagging the price action and it doesn’t tell you what the direction of the trend is.

Learn to Identify Strength of a Trend using Average Directional Index – ADX

ADX is calculated by using a moving average of price expansion over a specific period. The default settings are 14 but this can of course be changed to suit your style and timeframe. The ADX is derived from two directional movement indicators (DMI).

ADX oscillates between 0 and 100 where readins above 60 are rare. It is therefore important to split the values up into categories.

• 0-25 Sideways market
• 25-50 Trending market
• 50-75 Strong trending market
• 75-100 Very strong trending market

Tips and ideas

So, how can we trade using the average directional index? The ADX is a great tool to help you pick the best trending instruments before looking for specific entry signals. It is also a great tool for traders who trade the fade.

1. Using ADX as a filter when looking for continuation patterns is a great idea. Small continuation patterns such as flags work best when the preceding trend has been strong. By only taking the entry when ADX shows a reading of min 25 you will increase your odds tremendously.

2. If you are a trader who likes to picks tops and bottoms then it is better to do so in sideways market. Here you can simply say that if the ADX is under 25 then your filter gives you the signal to look for entries.

ADX - Chart

Our Implementation

I personally like being a bit picky about my trades so I add a little rule to my ADX filter saying that ADX needs to be above 25 for 3 bars before I considering it to be trending. The opposite can be said for a ranging market of 3 bars under 25. Look back on some charts to see what length works best for you.

How To Trade Using Average Directional Index (ADX)

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http://www.youtube.com/watch?v=Csq7gDnbapI&feature=relmfu

http://www.informedtrades.com/
A lesson on how to trade the ADX for traders of the stock, futures, and forex markets.

Link to the formulas behind the ADX: http://hubpages.com/hub/ADX

Link to Additional Resources on Trading the ADX:http://www.informedtrades.com/4529-six-resources-help-you-trade-adx.html

In this lesson we are going to learn about the Average directional Index (ADX), an indicator which helps traders determine when the market is trending, when the market is ranging, when the market may be about to change from trending to ranging or vice versa, and to gauge the strength of the trend in the market.

When plotted below the chart the ADX Line is normally accompanied by two other lines which are known as the +DI and --DI Lines.

Example of the ADX:

I am not going to go into the formulas for the Indicator here however you do need to know that:

• The ADX line is composed of two other indicators which are known as the Positive Directional Index (+DI Line) and the Negative Directional Index (-DI Line).
• The +DI Line is representative of how strong or weak the uptrend in the market is.
• The --DI line is representative of how strong or weak the downtrend in the market is.
• As the ADX line is comprised of both the +DI Line and the --DI Line, it does not indicate whether the trend is up or down, but simply the strength of the overall trend in the market.

If you would like a deeper explanation of the computation of the indicator you can find it here: http://hubpages.com/hub/ADX

As the ADX Line is Non Directional, it does not tell you whether the market is in an uptrend or a downtrend (you must look to price or the +DI/-DI Lines for this) but simply how strong or weak the trend in the financial instrument you are analyzing is. When the ADX line is above 40 and rising this is indicative of a strong trend, and when the ADX line is below 20 and falling this is indicative of a ranging market.

So one of the first ways traders will use the ADX in their trading is as a confirmation of whether or not a financial instrument is trending, and to avoid choppy periods in the market where many find it harder to make money. In addition to a situation where the ADX line trending below 20, the developer of the indicator recommends not trading a trend based strategy when the ADX line is below both the +DI Line and the --DI Line.

Example:
Another way that traders use this indicator is to identify the potential start of a new trend in the market. Very simply here they will look from below the 20 line to above the 20 line as a signal that the market may be beginning a new trend. The longer the market has been ranging, the greater the weight that most traders will give this signal

Example:

Another way traders use the ADX is as a signal of trend reversals. When the ADX is trading above both the +DI line and the --DI line and then turns lower this is often a signal that the current trend in the market is reversing and traders will position themselves accordingly:

Example:
The final example that I am going to cover on how traders use the ADX is to position to trade long when the +DI crosses above the --DI (as this is a sign that the buyers are winning out over the sellers) and to position to trade short when the +DI line crosses below the --DI (as this is a sign that the sellers are winning over the buyers). As with the other crossover strategies that we have covered used alone, the DI crossover is prone to many false signals.

Example:
That completes our lesson for today. You should now have a good understanding of the ADX and several different ways that traders use this in their trading. In tomorrow's lesson we are going to look at a new indicator which is called the Parabolic SAR, which many traders use to set stops when trading trends in the market.

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http://thetrader.hubpages.com/hub/ADX

ADX Indicator

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By thetrader

• ADX Indicator on Dow Jones Industrial Index

ADX - Average Directional Index - is atrend indicator which fluctuates between 0 and 100. Readings below 20 indicate a weak trend or ranging market and readings above 40 indicate a strong trend. ADX does not indicate direction but rather just thestrength of the trend, up or down.

Often plotted with ADX are two lines that indicate direction. The lines are +DI (positive directional indicator) and -DI (negative directional indicator). If the +DI line is above the -DI line, then the trend is considered bullish. Crosses of the +DI and -DI lines generate buy and sell signals. For example, if +DI crosses above -DI, then a buy signal is generated.

Formula

ADX = modify moving average of DX

DX = 100 x ( (+DI - -DI)/( +DI + -DI) )

+DI = +DMn / TRn , -DI = -DM / TRn

+DM = Ht - Ht-1 , -DM = Lt - Lt-1

CL = Ct - Ct-1

TR = largest of +DM,-DM ,and CL

where :

+DI = current positive directional index

-DI = current negative directional index

+DMn = current modified moving average of +DM

+DM = current positive directional movement value

Ht = current hign

Ht-1 = previous high

Lt = current low

Lt-1 = previous low

-DMn = current modified moving average of -DM

-DM = current negative directional movement value

TRn = current modified modified moving average of the true range

TR = true range

n = number of periods

DX = current DX

reference from : J.Welles Wilder

Trading Strategy

A move below 40 from above indicates that the trend is slowing. Since most option strategies rely on large price movements in short timeframes, a slowing trend is bad. Therefore an ADX move below 40 would indicate that it is time to close positions.

Conversely, an ADX indicator move above 20 from below indicates that the sideways trading is over, and a new trend is developing. This would indicate that it is time to make a move, either bullish or bearish.

Also, signals can be obtained by looking at where the positive directional index +DI (green) and negative directional index -DI (red) lines cross each other. When the +DI crosses above the -DI from below, it is a bullish signal, such as in early February. When the -DI crosses above the +DI from below, it is bearish, such as in late April.

ADX Video

Related Articles

• ADX strategies Explained
• Trading with ADX and PSAR
• Breakout Trading Using the ADX on FutureSource Workstation / eSignal

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http://transcripts.fxstreet.com/2005/10/date_october_4_.html

10/04/2005

ADX strategies Explained

Date: October 4, 2005 14:00GMT 10:00EST

Expert: Adrian Aquaro, Head of Trader College LLC and True Market LLC

Topics:
- ADX - Formula
- How to Enter a trade using ADX
- Interpretation

Who is Adrian Aquaro? 
Adrian Aquaro has been a trader for the last 3 years, specializing in the International Foreign Exchange Market and acting as an Introducing Broker for the Latin America market. He heads True Market Services LLC and is also the director of Trader College LLC. He has vaste experience in forex education, making of him a leader in this particular part of the financial services industry.

Speech Material:

Welles Wilder created the Average Directional Movement Index (ADX), to measure the actual trend strength, bullish or bearish. It’s important to know if there is a trend, or if the market is flat, because in this case, there are some indicators that could be more useful than other.

ADX combines +DI with –DI and then smoothes the indicator with a moving average, to measure trend strength. Because it uses +DI and –DI,

ADX doesn’t say anything about trend way. Usually, ADX above 40 shows a strong trend, and under 20 shows a weak trend. In order to choose a trend, you can take an ADX above 20.

ADX FORMULA:

+ DI = the sum of bullish directional movement averages (+DM)
                                  TR (True range)

- DI = the sum of bearish directional movement averages (-DM)
                                  TR (True range)

TR (true range) = All bullish ranges averages (today session) / n session (14 default)

ADX= (+DM) – (-DM)
         (+DM) + (-DM)

Then, we will have a rate, which will show a trend if it is over 25%.

How to enter a trade?
ADX line must be above 25 this means that there is a wide direction movement trend.

When DI + Crossed DI- bullish you have to enter in the same candle stick this means TO BUY.

When DI- crosses DI`+ bearish you have to enter the trade in the same canble stick this means TO SELL

ADX is a closed indicator and works between 0 and 100.But is not so probable to see ADX above 60.

ADX under 20 shows a weak trend or flat market, and ADX above 40 means a strong trend.

ADX Line doesn’t show trends, but only the strength of actual trend.

TRIGGERS

· Buy Trigger : +DI crosses up -DI

· Sell Trigger : - DI crosses up +DI

· ADX Under 25 says: DO NOT ENTER A TRADE

Extreme point: You have to take the maximum or minimum for the time frame you choose, where +DI and –DI have crossed. +DI will be the max or min point.

These points are used as signals, for buy or sell. For example, if price goes above extreme point, you have a confirmed buy signal. If price can’t go above it, you have to be out of the market.

Intrepretation:

Click image to enlarge:

Sell cross: -DI (red line), crosses above +DI (blue line). ADX line (green) indicates a rate over 25%.

Buy cross: +DI (blue line) above ADX line, confirming that trend has a wide moving way

Sell cross: -DI line crosses above ADX green line; these means movement is right.

ADX line crosses 40 y has a pull back: this means that trend ir probably old.

False signal and correction: ADX indicator means that you have to go out of the market, and immediately, you have a signal in opposite way

Buy cross: ADX line works with indicator, as a resistance for de +DI line, and then, price can’t reach new maximum point, and market becomes flat.

Click image to enlarge:

Buy cross: +DI above –DI and +DI crosses above ADX line and price.

40% line is a resistance for +DI and market becomes flat.

ADX line goes above 40 and a trend line of ADX line after a flat market, and then, price and volatility rise:

Click image to enlarge:

A cross under 20% and ADX line in that level doesn´t show trend movements

ADX line crosses 25%

ADX crosses 40 level and pull back, it is anticipating that trend can become weak

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