The Average Directional Index (ADX) is a technical analysis tool used to measure the trend strength. The plus directional indicator (+DI) and the minus directional indicator (-DI) accompany the ADX line, highlighting the direction of the trend. Used together they form a trading system that is able to determine both the direction and strength of the trend.
The ADX is used to identify strong trends and potentially profitable entry and exit points. This indicator was developed and introduced to the public by Welles Wilder, a twentieth-century technical analysis guru.
The logic behind
How strong is the current trend? This is the question the ADX is perfectly capable of answering. The indicator was created with the sole purpose of quantifying the trend strength.
The moving average of price range expansion is used as the foundation of the ADX. The indicator consists of three lines: the ADX itself (yellow line), a +DI line (green line), and a -DI line (red line). The +DI measures the strength of the uptrend, while the -DI measures the intensity of the downward movement. The ADX line shows the overall trend strength by rising in both uptrends and downtrends.
When the +DI is above the -DI, bulls are said to have the directional edge. Alternatively, when the -DI is higher than the +DI, the directional edge belongs to bears.
It is important to understand that the ADX (the yellow line) demonstrates only the trend strength and not the direction of the trend. Trend direction can be determined by looking at the +DI and -DI (red and green lines) instead.
How to set up?
Setting up the Average Directional Index in the IQ Option platform is easy.
Click on the “Indicators” button in the bottom left corner of the screen. Then choose the ADX from the list of possible indicators.
Go to the “Set up & Apply” tab and simply click the “Apply” button if you want to use the indicator with standard parameters. Or you can adjust the latter to your liking. Note that by increasing the period you cut down ADX’s sensitivity and at the same time boost the indicator’s accuracy.
The ADX is ready for use.
How to use in trading?
There are two major ways to use the indicator:
1) DI Crossover
When the plus and the minus directional lines cross it usually means that the trend is reversing. This information can be used to determine optimal entry points. For investors who utilize this trading system the signals are the following:
- Enter the market (buy call options) when the +DI is above the -DI and the general trend is upward.
- Leave the market (buy put options) when the +DI is below the -DI and the general trend is downward.
2) Trend Strength
In trading, not only the direction of the trend matters. The trend strength is also important as it defines the amount of profit a Forex trader would be able to pull out of a deal. There are even situations (e. g. utilizing the strangle trading strategy) when the direction of the trend doesn’t matter until market volatility is high enough.
The ADX ranges from 0 to 100 with 0 being an equivalent of the absolutely flat market and 100 — an extremely powerful trend.
|ADX Value||Trend Strength|
|0-25||Absent or Weak Trend|
|50-75||Very Strong Trend|
|75-100||Extremely Strong Trend|
In this case, the ADX can be combined with other indicators that show the direction of the future price action movement.
The Average Directional Index is a truly unique technical analysis indicator that, combined with other indicators, can become an great trading tool in the hands of a trader. Used in a combination with +DI and -DI lines (as suggested in the IQ Option platform) it is not only capable of predicting the trend strength, but also the trend direction.
As any other indicator, however, it should be used with caution and double checked on different time frames. The ADX may be lagging behind the actual trend and can therefore provide outdated information.
Sources: IQ Option
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