Traders use dozens of technical analysis tools to succeed in the Forex market. Some evaluate the situation independently, studying the price chart and additional indicators. Others need help to cope with the abundance of technical information and connect the best Forex robots that offer ready-made solutions or trade independently.
In any case, indicators are vital. They help determine the trend direction and its strength. While most beginners focus on buy and sell signals, experienced traders try to understand how strong and sustainable the emerging trend is. The Average Directional Index (ADX) can help them with this. Below, we will discuss how to use average directional movement index in your strategy and how to calculate it.
Understanding the Average Directional Index (ADX)
What is average directional index? It is a useful technical tool developed by the famous financial analyst Welles Wilder in the 1970s. The indicator works regardless of the market direction and shows the trend’s stability. It takes values ??from 0 to 100. The higher the value, the stronger the trend. When interpreting it, you should check whether the price rises or falls since ADX does not work reliably in a flat.
We should start this ADX Forex indicator tutorial with the information on how it is displayed on the charts. The index usually consists of three lines that can be activated in MT4, MT5, and other platforms. Next to the ADX itself, a negative direction indicator (-DI) and a positive direction indicator (+DI) are shown. Using these additional curves, you can find out the strength of the trend and its direction. Even though the calculation of the index is quite complex, it is easy to use in real trading.
Average Directional Index Calculation
It is convenient to calculate the Average Directional Movement Index in Excel because the calculation requires using data from several periods (usually 14). Below is a step-by-step plan and the final average directional index formula. The information is provided for familiarization and a better understanding of how ADX works. In practice, the trading program automatically makes calculations and draws a chart. So, here is the step-by-step algorithm:
1. Calculate +DM (Directional Movement) and -DM for the calculation period (Wilder advised taking 14 intervals) using the formulas:
+ DM = current candle high - previous candle high
- DM = previous candle low - current candle low
The largest value will be used in further calculations.
2. Calculate the true interval using one of the formulas:
TR = current candle high - current candle low
TR = current candle high - and previous candle close
TR = current candle low - previous candle close
Use the largest value in calculations.
3. Calculate average values of +DM, -DM, and TP for 14 periods.
4. Calculate +DI and -DI using the formulas:
+DI = ((Smooth+DM)/ATR)*100
-DI = ((Smooth-DM)/ATR)*100
where ATR is the Average True Range.
Find the Directional Index (DI) using the formula:
DI = ((+DI - -DI)/(+DI + -DI))*100
5. Calculate the average directional index indicator for 14 periods using the formula:
ADX = ((Previous ADX * 13) + Current ADX)/14
As a result of these complex operations, you will get a curve that will quite accurately display the current trend’s strength.
Using ADX in Trading Strategies
Despite the simplicity of its visual display, the ADX indicator contains much information. Thus, the main line can be used to determine the trend's strength, and the auxiliary lines — for possible reversals. All this data can be successfully incorporated into your average directional index strategy and used with other methods.
The strength of the trend shows the best moment to open or close a deal. It demonstrates the ratio of sales volume to purchase volume and gives a general understanding of the market players’ confidence. With approximate parity between sellers and buyers, we see a flat on the chart, and the ADX curve tends to zero. And vice versa, the ADX chart goes up if the balance shifts towards bulls or bears.
To use the ADX Average Directional Index in your trading strategy, you should correctly interpret its values. Below are approximate ranges and their meanings:
- Up to 20%. The range between resistance and support levels is low. The price almost does not change. At this time, it is best to watch and wait for additional confirmations.
- From 20% to 30%. It is too early to open a position at this stage, but there is a tendency for a strong trend to emerge. It makes sense to check +DI and -DI here to have information about the direction.
- From 30% to 40%. Confident confirmation of the trend. This is a favorable moment to open a position.
- From 40% to 50%. The average directional index meaning of this value is the most clear. The trend has the biggest momentum here.
- More than 50%. In this range, the trend can fade and change direction. It is important to analyze other indicators and wait for reversal signals here.
ADX indicator Forex sometimes gives false signals, especially on small timeframes, but, in general, it is very accurate. It is also useful to consider what signals about the trend direction are given by +DI and -DI:
- +DI crosses -DI from bottom to top and continues to move up. This is a bullish trend signal.
- +DI crosses -DI from top to bottom and continues to move down. This is a bearish trend signal. The maximum divergence of the two curves means a strong trend. A price reversal is very likely here.
Using this data in your work, you get an additional tool that will help you make more balanced and accurate decisions.
Limitations on ADX Usage
If you know how to calculate average directional index in Forex, this is still not enough for proper implementation. To use it profitably, you need to understand all the possible limitations. They can refer both to the ADX line and DI lines.
The situation in which +DI and -DI are close or intersect means an approximate market balance. The market can remain in this state for quite a long time, and therefore, frequent intersections can be misleading. It is important to wait for a greater divergence so that it can become the basis for your decision.
The same applies to the indicator value. If the average directional movement index Forex has risen above 20% or even approached 30%, this is not yet a 100% signal to open a position. The curve can just as quickly fall and return to the flat zone. You can test your hypotheses using other indicators so as not to enter the market too early.
ADX on Forex Trading: Practical Tips
To learn how to use average directional index and get the most out of it, you can use the following expert tips:
- Do not pay attention to ADX when the price chart is flat. During this period, the indicator can give false signals.
- The beginning of the trend is in the zone from 20% to 30%. Enter the market when ADX reaches the end of this range.
- For different currency pairs, the ranges may differ slightly, so it is important to make your own observations.
- Do not use the timeframes below H1.
By following these tips and combining an ADX indicator for Forex with other tools, you’ll be able to make more effective and profitable deals.
The Bottom Line
The ADX Forex index combines two key functions. It shows the strength of the trend, and its additional lines provide information about possible reversals. The indicator has a rather complex formula, but it is automatically calculated on all trading platforms. When using it, you will be able to enter trades and exit the market at the right time. Of course, you should remember about possible false signals and use the ADX Forex trading strategy only in combination with other tools.
