Welcome to Lesson 6 of the Forex Indicators series. In this part, we focus on the ADX indicator, a powerful tool to measure trend strength and direction.
The average directional index (ADX) is widely used to identify whether the market is trending or ranging. The ADX indicator consists of four main components: the ADX line, the positive directional indicator (DI+) line, the negative directional indicator (DI−) line, and the critical level at 20.
What is the ADX Indicator?
The ADX indicator measures trend strength but does not indicate the trend direction itself. Instead, it works together with the positive and negative DI lines to provide a complete picture.
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When the ADX line is below 20, the market is considered to be in a range or consolidation phase.
When the ADX rises above 20, it signals that a new trend may be emerging.
How to Use the ADX Indicator in Trading
If the ADX is below 20, this suggests low volatility and ranging price action. During this time, you can use other indicators like the stochastic oscillator to identify overbought or oversold conditions and take range-bound trades.
When the ADX crosses above 20, it usually indicates the end of consolidation and the start of a trending market. At this point, you should pay attention to the positive DI and negative DI lines:
If the positive DI line is above the negative DI line, the trend is bullish.
If the negative DI line is above the positive DI line, the trend is bearish.
Using DI Line Crossovers to Confirm Trend Direction
The height of the peaks after DI crossovers is also important:
If, after a crossover, the opposing DI line's peak is lower than the previous dominant DI's peak, the movement may be just a retracement. This means the current trend is likely to continue.
If the opposing DI line’s peak surpasses the previous dominant peak, it may signal a trend reversal, indicating it is time to reconsider long positions or prepare for short trades.
ADX Indicator Components
Function
ADX Line
Measures trend strength
Positive DI Line (DI+)
Indicates bullish strength
Negative DI Line (DI−)
Indicates bearish strength
20 Level
Threshold to differentiate range/trend
Summary
The ADX indicator is essential for traders wanting to distinguish trending markets from ranging ones and measure trend strength effectively. Understanding how to interpret the ADX line alongside the positive and negative DI lines will help you decide when to enter and exit trades based on trend conditions.
Use the ADX indicator combined with other tools like the stochastic oscillator to improve your trading decisions.Try applying the ADX indicator with your trading strategy today by joining PROP365, where you get access to professional tools and real-time data to enhance your forex trading success.
