Average Directional Index (ADX)
Average Directional Index (ADX)
ADX staying below 20 level — there is no trend or the trend is weak.
ADX moving above 20 level — trend is strong.
ADX passing 40 level — trend is extreme.
ADX value rising — trend is going
stronger, falling — trend is weakening.
+DI stays on top of -DI — uptrend is in place.
-DI stays on top of +DI — downtrend is in place.
Two DI cross — trend is changing.
Average Directional Index (ADX)
The Average Directional Index (ADX) depicts a presence or absence of a trend. ADX advices on the strength of the dominant forces that move market prices here and now.
In other words, ADX advices on trend tendencies: whether the trend is going to continue and strengthen or it is about to lose its positions.
The author of Average Directional Index J. Welles Wilder considers his ADX indicator as a primary achievement; and only because signals given by ADX are not an easy to take a grasp of from the first look, many Forex traders avoid using ADX in favor of more visually comprehensive indicators.
How to interpret ADX
ADX indicator has 2 lines: ADX itself (white), +DI (green) and -DI (red).
Traders then need to draw a horizontal line at the level of 20.
All readings of ADX which are below 20 suggest a weak and unclear trend, while readings above 20 indicate that a trend has picked up.
That is, basically, the simplest explanation of the purpose of ADX. ADX allows Forex traders to determine whether the trend is strong or weak and thus choose and appropriate strategy to trade with: a trend following strategy or a strategy fit to consolidation market periods with no significant price changes.
There is also additional line to be added to ADX indicator window - at 40 level.
How to trade with ADX
Trading with ADX looks as follows:
If ADX is traded below 20 - there is no trend or the trend is weak, thus a non-trend-following strategies should be used, otherwise losses may occur as a result of false signals and whip-saws taking place. An example of non-trend-following method is channel trading.
If ADX is traded above 20 but below 40, it is time to apply trend following methods. An example would be: Forex trading Moving averages or or trading with Parabolic SAR indicator.
When ADX reaches 40 level, it suggests an overbought/oversold (depending on the trend) situation on the market and it is time to protect some profits of at least move Stop loss order to a break even.
When ADX passes 40 level, it is a good time to begin collecting profits gradually scaling out of the trades on rallies and sell-offs and protecting remaining positions with trailing stops.
ADX -/+ DI lines are used for spotting entry signals. All -/+ DI crossovers are disregarded while ADX remains below 20. Once ADX peaks above 20 a buy signal occur when +DI (green) crosses upwards and above -DI (red). A sell signal will be the opposite: +DI would cross -DI downwards.
If after a newly created signal another opposite crossover happens within a short period of time, the original signal should be disregarded and position protected soon or closed.
ADX indicator is never traded alone, but rather in combination with other indicators and tools. ADX indicator most of the time gives much later signals comparing to faster reacting moving averages crossover or Stochastic, for example, however, reliability of ADX indicator is much higher than for other indicators in traders' toolkit, which makes it a valuable tool for many Forex traders.
And just one more idea to test out:
When ADX rises above 20 for the first time and then goes flat for some time, there is believed to be a new trend being born and the reason for ADX being currently flat is because market reacts to this new trend formation by making first initial correction. During this correction it is a good time to initiate new orders.
Developed by Donald Lambert and first made public in 1980, the commodity channel index is a well-known tool used by some commodity and forex traders for identifying secular moves, and trading them. The CCI has a crossover line at zero, and an overbought level at 100, while values below -100 are regarded as signalling an oversold condition. The CCI is an oscillator. Here we see the indicator in action in the price chart above. It is interesting to note that the CCI gives many false signals even at extreme values. For example, the lowest value for our indicator, at -283.576 was recorded during a very minor, and passing bottom on the chart. As with most high sensitivity indicators using the ATR requires a lot of practice and patience in mastering it. Calculation of the CCI To understand how the CCI is calculated, we need to understand three different, yet simple mathematical concepts. The first is the typical price, otherwise known as the pivot point, which is the average (mean) of the high, low, and close for a trading period. Pivot Point, Typical Price = H + L + C)/3 The mean absolute deviation (MAD) is the sum of the differences between the typical prices and their moving averages over the indicator’s period divided by the same. So, MAD(TP) = Sum of (TP-SMA(TP))/Indicator Period The indicator is then calculated according to the formula below: CCI = (TP- (SMA (TP)/ 0.015*MAD(TP)) Here what we do first is subtracting the simple moving average of the typical price from the typical price itself (TP-SMA(TP). If you’ve used moving averages, it’s very easy to understand why this is being done. Remember, if the price is above the SMA, we usually interpret this as a sign that the trend is an upward one, although its momentum will be a matter of further analysis. Thus the first component (TP- (SMA (TP) determines the relationship of the price to its moving average – and also whether the indicator value is a negative or positive number. The denominator of the equation serves the purpose of comparing this difference to its historic average. Finally, the 0.015 factor is for amplifying the fluctuations in the indicator, so that the changes are easier to note visually. So what we do is in fact just comparing the today’s equivalent of the MAD with its historic value, thus gaining an indication of how extreme today’s price is in the context of the past price action. Trading with CCI The CCI is used mainly as an overbought/oversold indicator similar to other indicators like the RSI. The overbought/oversold levels exists above 100, and below -100, respectively. Many traders prefer to focus on divergence/convergences between the price and the indicator with the purpose of reducing the number of trade signals, and avoiding whipsaws. The CCI was designed for the commodity market, but any market where prices show a tendency to move in cycles will prove to be fertile ground for its use. The forex market, with its cycles dictated by interest policy, and the economic boom bust cycle, is a suitable field for the application of the CCI. It is most important to remember that the CCI is a highly volatile indicator, and causes a lot of whipsaws. Traders need to be conservative about their risk management strategies when using it. Accessibility CCI is not as widely available as some other indicators of the same type, such as the stochastics or RSI indicators. MetaTrader, DealBook, TradeStation systems of major brokers do offer it, but due its lesser popularity among forex traders, it is a good idea to check beforehand with a demo account if it happens to be your favorite indicator. Conclusion CCI can be very useful with a few additional rules for validating its signals. As with the Williams Oscillator, you can choose to act on a signal only if it remains valid for a period of 10 days or so, leading to better, and more convincing overbought/oversold signals. Or you can combine the CCI with other indicators of different types for filtering out faulty signals. The key to using the CCI successfully is a careful approach to risk controls. It is volatile, so you should be prepared for unexpected outcomes and set your trading scenarios up in accordance.
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