The primary purpose of the Average Directional Index, or ADX indicator, in Forex is to measure the trend strength of the market. It’s also great for detecting range markets.
Moreover, a trader can use the total ADX system as a directional indicator.
The ADX is one of the five technical indicators created by J. Welles Wilder, Jr.
Professional traders usually stack the odds in their favour when they’re able to detect the formation of a new trend correctly. That’s why most experienced traders use the ADX to generate powerful trading strategies related to market trends for intraday trading in Forex.
How to calculate the average directional index indicator
There are two Wilder’s directional indicators that make up the ADX indicator in a Forex trading chart. They are:
- The positive directional indicator (+DI)
- The negative directional indicator (-DI)
Both indicators complement the ADX indicator by defining the directional movement of the market. They do this by equating the high and low of the current period with the previous period’s high and low.
The directional movement can either be positive (+DM), negative (-DM), or zero in value. It cannot be positive and negative or up and down at the same time.
When the +DM has a value that is not zero, the –DM will be zero. If the –DM has a value that’s not zero, the +DM will be zero.
The calculation is as follows:
- Positive Directional Movement = Current high – Previous high = +>Current low – Previous low
- Negative Directional Movement = Previous low – Current low =+>Previous high – Current high
- Positive Directional Movement (+DMI) > Negative Directional Movement (-DMI) = Prices moving up (ADX measures strength of the Uptrend)
- Negative Directional Movement (-DMI) > Positive Directional Movement (+DMI) = Prices moving down (ADX measures the strength of the Downtrend)
The good news for traders is that the MT4, MT5, and other trading platforms automatically perform these calculations.
The image of the chart below reveals the ADX on a Forex trading chart via an MT4 platform.
The picture above shows how the ADX indicator looks in a one-hour trading chart for CAD/CHF
How to read the ADX indicator in Forex trading
It’s simple to read the ADX indicator when trading Forex. In fact, understanding the calculations isn’t a prerequisite because the trading software handles that.
The oscillating indicator usually moves from 0 to 100 and back. When its values read below 20, it indicates there’s a weak trend in the market, but when the readings go above 50, it signals a strong trend.
In other words, when the ADX is low, it signifies that price is moving sideways or in a range. When it’s high (above 50), the price has garnered enough momentum in one direction.
It’s wise to stay away from the market when the ADX is reading low (especially readings below 20). Also, it’s crucial to note that the ADX does NOT determine whether the price will go up or down. Instead, it only measures the power of the current trend.
Most professional traders use the ADX at the beginning of a trading day to spot emerging trends in collaboration with other key indicators. That way, they enter the trend early enough to become very profitable.
See an example of how an ADX helps a trader to spot ranges and rising trends.
In the one-hour intraday GBP/USD chart above, we can see the ADX indicator at work. When the red ADX line crosses above 50, a substantial expansion trend occurred downward. As soon as the red ADX went below the 50 reading, the price entered a range or sideways market.
At the time of this trade, the red ADX line hasn’t crossed above the 50 readings. Professional traders will wait for the line to pass above 50 while combining it with other indicators to get the price direction and make huge profits.
The benefits of the ADX indicator
A strong trend in motion is most likely to continue, then pull back. Trading strong trends can give you great odds of trade success. The ADX is a great indicator to trade strong trends and make significant profits.
The downsides traders face when trading this indicator
The indicator usually gives wrong readings on a range market. A trader cannot get the direction of price on the market with this indicator, and the ADX doesn’t give entry or exit points.
The bottom line
Trading with support and resistance levels alone isn’t enough for a trader to make profits on the Forex market. That’s why professional traders combine other indicators, like the ADX, to confirm price trends. The indicator is pretty useful for those who trade trends as well as different strategies.