The Average Directional Index, or ADX for short, is another example of an oscillator. It fluctuates from 0 to 100, with readings below 20 indicating a weak trend and readings above 50 signaling a strong trend.
Unlike the stochastic, ADX doesn't determine whether the trend is bullish or bearish. Rather, it merely measures the strength of the current trend. Because of that, ADX is typically used to identify whether the market is ranging or starting a new trend.
Take a look at these neat charts we've pulled up:
In this first example, ADX lingered below 20 within the spaces colored blue. Price just couldn’t move aside of the ranging formation. The ADX readings below the 20 is doing a great job letting us know there is no trend in sight.
However, in the next color red section, you can see that the ADX below climbed above 50, signaling that a strong trend could be waiting in the wings.
And true to that, we can see a beautiful downtrend with so many profits to pick from. Perfectly obeying the readings of the ADX signaling strength in price movement
Now, let's look at another example:
With a perfect similarity to the initial example we treated, ADX lingered around the 20 levels for quite a while. At that time, the price on the chart was also ranging. After a while, ADX rose above 50 and the price also broke out from the range and headed upwards.
It’s obvious we can see an uptrend when the ADX went to the 50 level. That’s an amazing profit to lock into your trading wallet.
Now the little twist to ADX unlike other oscillators is the fact that it doesn’t exactly tell you whether it's a buy or a sell. What it does tell you is whether it'd be okay to jump in an ongoing trend or not.
Once ADX starts dropping below 50 again, it could mean that the uptrend or downtrend is starting to weaken and that it might be a good time to lock in profits.
How to Trade Using ADX
One way to trade using ADX is to wait for breakouts first before deciding to go long or short. ADX can be used as confirmation whether the pair could possibly continue in its current trend or not.
Another way is to combine ADX with another indicator, particularly one that identifies whether the pair is headed downwards or upwards.
ADX can also be used to determine when one should close a trade early.
For instance, when ADX starts to slide below 50, it indicates that the current trend is losing steam. From then on, the pair could possibly move sideways, so you might want to lock in those pips before that happens.
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