On the other hand, it takes lots of inaction for the ultra sensitive 2-period ADX indicator to drop below 25. ADX can also be used to determine when one should close a trade early. One way to trade using ADX is to wait for breakouts first before deciding to go long or short.
The second ADX indicator trading rule says, when the ADX is above 25 is enough to signal the presence of a strong bullish/bearish trend. We need to be very careful about how we read and interpret the ADX indicator. It also aligns with the tried-and-true rule that day traders stop trading when the market stalls. A weak trend is a sign of consolidation, so it’s best to step back until things start moving again. The direction of the ADX line is important for reading trend strength. When the ADX line is rising, trend strength is increasing, and the price moves in the direction of the trend.
In the above case, a trader could land up focusing on trend momentum while overlooking other important elements such as volatility. A common misperception is that a falling ADX line means the trend is reversing. A falling ADX line only means that the trend strength is weakening, but it usually does not mean the trend is reversing, unless there has been a price climax. As long as ADX is above 25, it is best to think of a falling ADX line as simply less strong (shown below). As a general rule, the shorter the period is, the more sensitive the technical indicator becomes to the price.
ADX has some weaknesses that make it unsuitable to be used as a standalone indicator. To start with, it is based on moving averages, which means that it is largely a lagging indicator that reacts slower to price changes in the market. ADX is also practically inefficient when trading less volatile or ranging markets. Furthermore, ADX crossovers can happen frequently and deliver choppy signals to traders. The idea is to combine the ADX with a complementary indicator that will provide a comprehensive analysis of an asset’s price. It is important to ensure that you do not combine the wrong indicators, which can lead to indicator redundancy and overemphasising information.
How to Use ADX (Average Directional Index)
We waited for the +DI to close above 20 level and the price to stabilize above the Keltner Channel and we entered long. You also need to recognize relevant support and resistance levels and to trade accordingly. This strategy is not enough to be profitable, as it will offer a lot of false signals. I personally prefer to filter the entries with the on balance volume. Of course, other indicators could be added for this setup, in order to filter out the market noise.
- Other technical analysis indicators similar to ADX include the Parabolic SAR, Envelopes and Moving Averages.
- ADX also alerts the trader to changes in trend momentum, so risk management can be addressed.
- Those interested in learning more about ADX and other financial topics may want to consider enrolling in one of the best technical analysis courses currently available.
- In a range, the trend is sideways, and there is general price agreement between the buyers and sellers.
Thus, it detects small and fleeting trends and rises above 75 easily. These short-lived trends are common but not profitable for trading. When the ADX is low, it highlights periods when the price is usually going sideways or trading in a range. For our entry signal, we’ll be using the RSI indicator that uses the same settings as the ADX indicator settings. Normally the RSI reading below 30 shows an oversold market and a reversal zone. However, smart trading means looking beyond what the textbook is saying.
Top ADX Trading Strategies
When the +DMI is above the -DMI, prices are moving up, and ADX measures the strength of the uptrend. When the -DMI is above the +DMI, prices are moving down, and ADX measures the strength of the downtrend. The chart above is an example of an uptrend reversing to a downtrend.
ADX shows when the trend has weakened and is entering a period of range consolidation. In a range, the trend is sideways, and there is general price agreement between the buyers and sellers. ADX will meander sideways under 25 until the balance of supply and demand changes again. Knowing when trend momentum is increasing gives the trader confidence to let profits run instead of exiting before the trend has ended.
Main ADX Indicator Trading Strategies FAQ
Other technical analysis indicators similar to ADX include the Parabolic SAR, Envelopes and Moving Averages. The best profits come from trading the strongest trends and avoiding range conditions. ADX not only identifies trending conditions, it helps the trader find the strongest trends to trade. The ability to quantify trend strength is a major edge for traders.
What are the best ADX settings for a 1-minute chart?
The best ADX settings for a 5-minute chart depend on the trader’s preferences and trading style. However, some commonly used settings are 7 for the period, and 20 for the threshold level. Before we even look to see if the market goes up or down, we must first wait for the ADX indicator to show a reading above 25. Based on the ADX indicator trading rules, a reading above 25 signals a strong trend and the likelihood of a trend developing. The first ADX indicator trading rule says, a reading below 25 signals a period of non-trading or ranging market.