The indicator is usually plotted in the same window as the two directional movement indicator (DMI) lines, from which ADX is derived (shown below). If we look at the first graph of this article, we observe that the ADX seems to oscillate up and down. Thus, we add the criteria that ADX for n-days must be higher than x. Perhaps surprisingly, the ADX improves many trading strategies. The Plus and Minus Direction Indicators are referred to as the Directional Movement Indicators (DM).

In range conditions, trend-trading strategies are not appropriate. However, trades can be made on reversals at levels of support (go long) and resistance (short). ADX calculations are based on a moving average of price range expansion over a given period of time. The default setting is 14 bars, although other time periods can be used. Is it possible to use the ADX indicator (Average Directional Movement Index) (DMI) to find a profitable ADX trading strategy? This article looks at the ADX indicator where we make some historical backtest to evaluate and analyze.

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But the average gain per trade goes up from 0.54% to 0.73% and the maximum drawdown decreases a little. Mr. Wilder established readings under 15 as non-trending and above 20 as trending. Since the year 2000, gold has never seen a reading above 25 for a 50-day ADX. The ADX is rarely above 50, and thus we can conclude that the S&P 500 doesn’t trend much. If we use a 50-day ADX, the highest reading since 1993 is just under 30.

For long-term trend analysis, a daily or weekly chart is more suitable. This allows you to view broader market trends and make more informed decisions. Conversely, an hourly or 4-hour chart may provide the immediate detail you need for shorter-term trading to spot quicker trend changes. Traders use the ADX to determine whether a market is trending and gauge the bitbuy review strength of that trend.

1. When applied to currency trading, the ADX indicator helps to measure the strength of a currency pair, to see whether the asset is increasing or decreasing in price.
2. No matter what your time frame is, we need a practical way to determine the direction of the trend.
3. So, if the price is going UP, and the ADX indicator is also going UP, then we have the case for a strong bullish case.
4. Moreover, a strong ADX trend may provide the confidence to allocate more money to a position, adjusting risk management parameters accordingly.

This information can be vital for deciding on market entry and exit points. Additionally, the ADX works well with other indicators, like RSI and ROC, providing a more comprehensive view of market conditions. What works best will vary depending on the market and timeframe you trade, as well as the trading strategy that’s used. The tests in this article will be carried out on the SPY ETF, which tracks the S&P-500.

ADX stock indicator

Unfortunately, Wilder’s book is out of print, but we are unsure if Wilder made the indicator a stand-alone indicator or used it together with other indicators. As you will see later in the article, we prefer to use it as a supplement to other indicators. The ADX hooked once price stopped its fall and entered the consolidation.

How to Trade Using ADX

In the AUD/NZD chart, there were 5 ADX signals and we marked each with a vertical line and an arrow indicating the direction of the signal. On the screenshot below, we set the DI period setting to 1 which means that the indicator just compares the two most recent candles. This is a good way of understanding the DI calculations quickly. Keep in mind, the DI just looks at the absolute high and the low (not the candle body). The next time you think a trend is changing and you need to decide whether to stick to this “friend” or cut ties, consider trying the ADX to confirm the trend’s strength.

I’ve got an Msc from Heriot-Watt University, Edinburgh (1996), in addition a to a business administration degree the Norwegian School of Management (BI – 1994). The optimization indicates the best results on the S&P 500 is 35 days for the DMs (DI) and 15 days for the ADX high/breakout. In general, high numbers on both optimizations give the best results.

Markets differ a lot, and you should always check to see so that your strategies and ideas work as you expect them to, before going live. This is explored in more depth in our article on how to build a trading strategy. Continuously monitor the ADX to gauge the strength of the trend.

Open an MT4 account now to practise your ADX strategy with virtual funds. When analyzing the ADX in etoro relation to price action, you may encounter situations where the two do not move in sync. Choosing the right time frame is crucial when utilizing the ADX indicator.

The best ADX strategy seeks to only capture those profits that emerged from the presence of a strong trend. Once the prospects of a strong trend fade away we look to take profits and wait for another trading opportunity. In order to determine the stop-loss location for the best ADX strategy, first identify the point where the ADX made the last high prior to our entry. Secondly, find the corresponding high on the price chart from the ADX high and there you have it your SL level. While it’s not a trading strategy per se, it’s a tool for finding more conservative signals. In any approach that uses the ADX, you can opt to replace it with the ADXR.

A lagging indicator, the ADXR produces trending signals after the ADX. The average directional index (ADX) is a technical indicator used by traders to determine the strength of a price trend for a financial security. Trading in the direction of a strong trend reduces risk and increases profit potential. Many traders consider the ADX to be the ultimate trend indicator because it is so reliable. In the late 1970s, Welles Wilder introduced the ADX Indicator to measure the strength of market trends. Wilder created ADX to quantify the momentum and directionality of price movements, thus aiding traders in distinguishing strong trends from weak ones.

We develop high-quality free & premium stock market training courses & have published multiple books. We also thoroughly test and recommend the best investment research software. By requiring that the 3-period ADX is below 50 we achieved the best equity curve, with the following result. As you see, the results get a little better with the ADX-filter, but we still have quite some drawdown. We require that DMI-plus is above DMI-minus and that the 14-period ADX is below 20, to enter a trade. Last but not least the best ADX strategy also needs a place where we need to take profits, which brings us to the last step of this unique strategy.