In our last lesson we went over Bollinger Bands, an indicator which helps traders gauge the volatility in the market as well as how high or low current prices are relative to historical prices. 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, how strong or weak a trend is, and when a trend may be about to start or reverse.
Example of the Average Directional Index (ADX)
I am not going to go into the formulas for the Indicator here however you do need to know that:
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: ADX Indicator
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.
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
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:
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.
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.
Your details are strictly protected, safe and never be sold or shared. We hate spam as much as you do.
Any articles, systems, strategies, reviews, ratings, news, research, analyses, prices or other information contained on this website, by Aboutcurrency.com, its partners or contributors, is provided as general market commentary and does not constitute investment advice. Aboutcurrency.com will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.
Risk Disclosure: Trading forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.