Proper trend identification is one of the keys to successful forex trading. ADX (Average directional movement index) is widely regarded as one of the best tools to determine direction and strength of a trend. ADX has very warm relationship with most of the forex indicators, as the signal accuracy of any forex strategy depends on trend and ADX excells in its identification.
Anatomy of ADX (Average directional movement index) forex indicator
ADX forex indicator quantifies trends strength with calculation based on moving averages. Those are applied on price range during chosen time period (14 by default). ADX is composed of main ADX line signalizing trend strength, and DMI + and DMI - lines signalizing trend direction.
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Main ADX line can move in range from 0 up to 100 (with 100 being very rare). Main ADX line doesn't signalize trend direction. It is only distinguishing trending from ranging market. Generally, readings below 20 are indicating ranging market and above 40 trending market. Range between 20 – 40 may signalize weaker trend, consolidation or reversal. Readings above 70 might signalize extreme trend that might get unstable and reverse.
DMI + trends above DMI –. Uptrend is in progress. With main ADX line measuring its strength.
DMI + trends below DMI –. Downtrend is in progress. With main ADX line measuring its strength.
Low ADX main line values often signalizes either accumulation or distribution. Activity that is necessary for major trend reversal. Falling main ADX line does not signalize immediate trend reversal. It only tells us, that trend is getting weaker and we should look for clues whether it will continue or potentially reverse.
Using ADX (Average directional movement index) forex indicator
ADX coupled with CCI for accurate entry signal within trend.
Almost any trading strategy can be improved by considering forex trend. By considering ADX readings for trends strength and its direction, we can filter out fake signals generated by forex oscillators such as relative strength index (RSI), stochastic or commodity channel index (CCI). Basic premise is, that we should only take signal in direction of trend detected by ADX.
Declining momentum - trend exhaustion.
ADX as momentum indicator
ADX also presents us with reliable information on trend momentum. We look at main ADX line and the peaks that it is forming for trend momentum estimation. Peaks on main ADX line are created by corrections within trend. By connecting them with trend line and comparing them to price chart, we can decide whether the trend is gaining or losing strength and momentum.
Breakout strategy trading with ADX
By using ADX we can find most interesting breakout situations at trend reversal zones. Those entries might be the best opportunity to enter the new born trend with great risk reward ratio.