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Average Directional Index (ADX) - How to spot trends

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Lesson 4

The average directional index (ADX) indicator is a technical trend strength indicator. Falling into the category of oscillators, the ADX indicator is plotted on the sub-window of the price chart.

The directional indicator is available on many trading platforms, including MT4. You can use it to spot upcoming trends.

Widely used across many financial markets, the average directional index indicator shows when trends are the strongest and when they are weakening. This indicator can provide crucial information for traders who prefer to avoid ranging markets.

Based on a combination of three components, the ADX indicator and the +DI and -DI variables, trend strength can be easily identified by the crossover of the positive DI index and the negative DI index. Furthermore, the momentum, or strength, of the trend is gauged by the value of the main ADX.

ADX technical indicator

The ADX indicator was developed by Welles Wilder in the late 70s and early 80s. Despite being one of the oldest technical indicators, the ADX is still widely used to this day by professional traders.

The technical indicator was first proposed by Wilder in a book titled New Concepts of Technical Trading Systems. In his book, Wilder provided a few indicators, which included the ADX, the Average True Range (ATR) and the parabolic stop and reverse (PSAR) indicator.

While earlier traders had to manually calculate the ADX values, these days most trading platforms do the job automatically. Still, it is good to have some basic idea of how the values are calculated.

The positive directional movement, or +DI, is based on the current high price minus the previous high. When this value is greater than the previous low minus the current low, the +DI moves higher.

The negative directional movement, or -DI, is based on the current low price minus the previous low. When this value is lower than the previous high price minus the current high price, the -DI moves lower.

How to use ADX in Forex

The ADX indicator is widely used in the forex market. Traders can use this indicator on the intraday to determine the trend strength. Commonly, the indicator is used alongside the moving average, which can signal trends.

Alternately, you can use price action based methods and validate the trade ideas based on the ADX indicator's values.

Typically, the most popular use for the directional indicator is to avoid trading in the ranging markets. This occurs when the ADX line falls to 25 or is moving close to this line. In some cases, you can also expect the line to fall below 25.

When this happens, the ADX indicator signals the currency pairs are trading sideways. Trend traders can use this information to stay out of the markets and prepare to enter a trade once the trend begins to strengthen.

Trend direction and crossovers

The trend direction can also be determined by the ADX indicator. For this, traders simply look at the +DI and -DI crossovers. Similar to a moving average crossover, the +DI and -DI indicate buy and sell signals.

Traders should also look at the ADX value. The ideal signals occur when the bullish or bearish crossover of the +DI and -DI coincide with the ADX line moving higher from the 25 level. This will signal a strong bullish or bearish trend. It is also the most preferred time to trade the forex market.

Buy/Sell Signals

Buy and sell signals can be determined by the crossover of the +DI and -DI values. However, this alone should not be used as the ADX crossover is not a reliable source for buy and sell signals.

The ADX indicator's value is an essential aspect that needs to be considered. The calculation for the indicator is based on the positive and the negative DI values, and the true range is also taken into consideration.

When all three variables are accounted for, traders can determine the trend strength. The ADX points to rising trends when it is above 25. Traders can, of course, change this value based on the markets and the time frame they are using.

How to trade binary with ADX

You can make use of the ADX indicator to trade binary options. As indicated, to use the directional indicator, you must first look for the bullish or bearish crossover of the positive and negative DIs, respectively, and also check for the ADX value.

Based on this, traders can purchase Put or Call options. For traders who prefer to trade binary options on an intraday basis, using the ADX indicator on a 1-hour or a 30-minute chart works best.

Let’s look at two examples of how to trade binary options using the average directional index.

The first step is to wait for a bullish crossover of the +DI and -DI and look for the ADX value to be above 30. However, this might not always be the case as the crossover might happen first. Therefore, look for an ADX value above 30 when the +DI is above the -DI. This suggests strong bullish markets.

ADX Call Signal

Based on the time of the day, you can then purchase daily Call options for an End of day expiry. The chart below gives an example of Call trades based on the ADX indicator.

ADX binary options call trade

The above example shows how to enter a Call trade after the bullish crossover of the +DI and -DI, followed by an ADX line that stays above 30.

ADX Put Signal

When trading Put options, wait for the -DI to be lower than the +DI and look for an ADX value greater than 30. Once the ADX line slopes or moves higher, you can purchase daily Put options for End of day expiry.

ADX binary options put trade

The Put option example above shows how to enter a Put trade. The price briefly rallies higher but falls sharply to close in the money by End of the day.

The ADX could be very helpful in avoiding ranging markets. It is a reliable tool when determining trend strengths. Traders can look at the values to trade binary options and forex just when the trend is starting to show signs of strength.

Notably, the ADX only detects the trend strength and partly the trend direction, which is based on the +DI and -DI values. Traders should also use other complimenting indicators to obtain more decisive signals for trading the forex market.

There are some risks when trading with the ADX indicator, but overall, it allows you to obtain profitable signals on a consistent basis.