Average Directional Movement Index Oscillator (ADX)

 

Average Directional Movement Index oscillator review

Average Directional Movement Index (ADX, fig.1) is an oscillator which measures the trend strength. Oscillator is based on the theory of the trader Welles Wilder, which was outlined by him in his book «New Concepts in Technical Trading Systems» as far back as 1970s. ADX was not created as a separate indicator, it is part of the system, which included another directional indicator of the market (DMI, directional movement index).

Average Directional Movement Index oscillator review

Fig. 1

The main feature of the ADX oscillator is that it measures only the strength of a trend, but not its direction. Therefore, it is used to determine the beginning of a new trend formation. ADX is an oscillator for Forex trading, the values of which range from 0 to 100, although movements above 60 rarely occur. If the value is below 20, it means that the trend is weak. If the values exceed 40, it means that the trend is strong. Therefore, if the indicator values cross the mark of 20 from the bottom up, it shows that the trend continues growing. If the 40 mark is crossed from top to bottom, then the trend is weakening.

ADX consists of a line constructed by the maximum values of bars +DMI, of a line constructed by the minimum values of bars –DMI and the ADX line itself. Ability of the ADX oscillator to determine the trend strength enables you to see the optimum moment of entering the market for buying and for selling and the profit taking moment. It has been empirically found that ADX functions in the optimum way after a consolidation period and not particularly well after sharp movements against a key trend.

It has also been practically proved that the indicator for Forex gives the most informative signals on timeframes from H4 and then, which does not exclude its using on other timeframes, but with less efficiency. Average Directional Movement Index indicator is quite popular, therefore it is preset in trading terminals. For example, in MT5 it is in the main list in the left navigation panel.

Sign in by broker’s terminal, add the ADX oscillator to the chart, and see what happens

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Average Directional Movement Index signals

The basic signal of the ADX indicator is an increase in its values, which shows that a trend is emerging (fig. 2). If with an increase in values ADX+DI rises higher, then DI is a buy signal. If +DI drops below -DI on ADX growth, it is a sell signal (Forex signals).

Average Directional Movement Index signals

Fig.2

If +DI is higher than -DI, despite that ADX is declining, this means that you need to take profit. You also need to record the results when +DI is located below -DI with decreasing ADX. When indicator reaches 50 is also a profit-taking signal, since such values show that the trend has been exhausted. If ADX values rise from a mark below 15, and intersect the +DI or -DI values, this confirms the existing trend. The series of ADX peaks that are tracked are visually informative. Thus, a series of peaks each of which is higher than the previous one shows that the trend strength is growing. A series of declining peaks indicates a decrease in trend strength.

When working according to ADX signals, it is necessary to remember the rule of extremum points that was developed by Wells Wilder for this indicator. The extreme point when a buy signal appears is the maximum price of the day of intersection, the minimum price with a sell signal, respectively. The extreme point serves to clarify the conditions for entering the market (Forex trading). Thus, buy positions are opened when the price is above the extreme point, and sell positions are opened when the price is below the extreme point. If the price does not intersect the extreme point, then start trading is considered to be irrational.

 

Strategies with ADX

The simplest strategy using Average Directional Movement Index is to determine occurrence of a trend and track the indicator behavior, deciding independently when and what positions should be opened based on the trend strength. But this strategy is not reliable, so ADX is used with other indicators (Forex strategies). The strategy (fig. 3) using the ADX and MACD indicators is carried out on the time frame M15 and higher. In this case, the following parameters are set in the settings: ADX (14), MACD (5, 25, 9) and MA (9); moreover, a simple moving one with a period of 9 is additionally set.

Strategies with ADX

Fig. 3

The main indicator during this strategy implementation will be MACD, which will show the trading direction. The ADX indicator is adjusted in this way, the DI- DI + signal lines were not visible on the chart. The average moving MA (9) is superimposed on the ADX. A buy signal will be intersection of ADX with MA from the bottom up with a positive MACD. If the MACD value is negative, then this will be a sell signal. Then the following signals are evaluated – if the subsequent signal is opposite to the previous one, the transaction is closed. When a signal coincides with the previous one, a new order opens.

Another strategy (fig. 4) uses ADX and ATR. It is worth reminding that ATR (Average True Range) shows volatility across range A of fluctuations in maximum and minimum prices and closing prices. This indicator was also developed by Wilder.

Strategies with ADX and ATR

Fig. 4

Indicators are set with ATR (11) parameters, a moving average with a period of 21 is superimposed on the ATR, ADX (14). A buy signal is placement of the ADX indicator above 25; placement of the ATR indicator above MA, and +DI should intersect -DI. A sell signal is placement of the ADX indicator above 25, the placement of the ATR indicator below the moving average and DI should intersect + DI.

The next strategy (fig. 5) is built on ADX and two exponential moving averages. EMA with a period of 4, EMA with a period of 11, ADX with a period of 13 are plotted on the chart – this should be noted, since the standard period is ADX 14.

Strategies with ADX and EMA

Fig. 5

A buy signal will be location +DI above –DI, the ADX indicator should be above level 22, and EMA should intersect the EMA (11) from the bottom up. To open a position, it is important that all three of the described conditions are fully met. To open a sell order, +DI should be placed below -DI, the ADX indicator should be above level 22, and EMA should intersect EMA from the bottom up. It is supposed to close a position when EMAs are intersected in the direction opposite to the signal one.

The following strategy (fig. 6) uses Stochastic Oscillator and exponential moving averages together with ADX. The strategy was developed for timeframe M15 and higher. ADX standard settings – period 14, level 20. EMAs with periods of 30, 15 and 5 are also superimposed on the chart. Stochastic is set with an additional level of 50.

Strategies with ADX and Stochastic

Fig. 6

Sell positions are opened when the ADX crosses level 20 from the bottom up, the following order of arrangement occurs from the bottom up: EMA (5), EMA (15), EMA (30) from the bottom up, while the stochastic crosses the level 50 from top to bottom. Buy positions are opened in opposite conditions for all indicators, except for ADX, which should cross the level 20 from the bottom up as in the first case. A strategy where ADX is complemented by a simple MA is also applied; it is optimally implemented during the period when ADX is growing. And there is a strategy where ADX works in tandem with stochastics only. In this case, the optimum results will be achieved when working in a flat movement, if there is a trend growth, as can be seen from ADX, then the stochastic will generate false signals.

There is a strategy in which the RSI indicator is used along with ADX and EMA. The strategy is implemented on a timeframe from H1 and above. It is worth reminding that RSI is the Relative Strength Index, it was also developed by Wilder. RSI indicates oversold or overbought assets. RSI with a period of 25 or 14 is used in this strategy. ADX is applied with standard parameters. Buy positions are opened when prices are above EMA (20), the RSI line is above 50 but below 70, and the main ADX line is above level 20. Sell positions in this strategy are opened when prices remain below EMA (20), the RSI line is below 50 but above 30, the main ADX line is also above 20. According to this strategy, only one position is opened, the next position can be closed only after completion of the previous one.

ADX is applied in strategy with Parabolic SAR (PSAR). The strategy uses the +DI, -DI lines. Parameters for Parabolic – 0.02; 0.2, the ADX is set to level 50. Buy positions are opened when the +DI line is placed above -DI, and PSAR shows the possibility of opening a long position. Sell positions are opened when +DI is placed above -DI and the signal is confirmed by Parabolic. If the lines DI and -DI are intersected again, and ADX shows crosses the mark 25, you need to exit the auction.

In another strategy (fig. 7), Stochastic and Нeiken Аshi are used along with ADX. HA is a variation of Japanese candles, which is characterized by more accurate signals. The strategy is implemented on a timeframe from M5 and higher. ADX indicator is set with a period of 14, and stochastic parameters are 5, 3, 3. Buy positions are opened when the price is above the moving average Heiken Ashi, and two bars are visible on the chart that show an upward trend. ADX should be placed above 20, the stochastic should be directed up. To enter the sale, the price must be lower than MA НА, and two bars must be visible on the chart, which show a downtrend. ADX is located below 20, the stochastic shows a downward movement.

Strategies with ADX and Heiken Ashi

Fig. 7

 

Summary

ADX indicator can be very useful in trading, as it enables you to do a very important job: determine beginning and end of a trend. This reduces significantly the trading risks. The ADX indicator is also effective as a filter in multi-indicator strategies. However, ADX is characterized by a number of serious drawbacks that need to be considered when working with it. The indicator is generally unreliable during the long-term trends or when high volatility is observed, but it is not clear where the trend is moving. Moreover, the intersection signal -DI and +DI is very often false, under any conditions.

It has been proven in practice that ADX is quite informative and accurate only if flat movement dominated the trend. ADX can give signals very late, as the indicator formula implies double data smoothing. Performance of such a tool like Average Directional Movement Index (ADX) is rated at only 60%. Therefore, it can only be used in combination with other indicators.


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