June 24, 2008
The ADX And Directional Movement Technical Indicators
The ADX and the directional movement indicators are both very useful indicators for indicating when a new trend is about to start, and when a strong trend is petering out.
I've grouped the two indicators together because on certain charting software, such as the one I use, you can plot them both on the directional movement chart, which is why I personally see them both as one indicator.
So how can you use these indicators?
Well I personally like to display a 14-period chart displaying both indicators first of all. Then I add a horizontal line at +20 (some traders prefer 25 but I've always used 20).
This line is very important because when the ADX crosses the line from below, this signifies the start of a new trend. Similarly when the ADX crosses below 20 and stays below 20 there is no trend and you should be waiting for an upwards crossover before entering a position.
A rising ADX that is above 20 signifies a continuing trend, with the higher the value the stronger the trend. When the ADX reaches a high level between around 40 and 60, and starts falling, this often means a trend is losing momentum, and you may like to close out and possibly reverse your position.
What the ADX indicator doesn't tell you is the actual direction of the trend itself, only the strength of the trend. You can of course use other indicators to gain this information, but a powerful method of trading is to use the directional movement indicator in conjunction with the ADX.
The directional movement indicator consists of the DI (histogram) and the DI+ and DI- (lines). It's the two latter indicators that are the most important. When the DI+ is above the DI-, we're in a bullish trend and vice versa. The most important signal, however, is when the two cross. The DI+ crossing the DI- from below often signals the start of a new bullish trend and vice versa.
This information combined with the ADX crossing upwards through the 20 level is a very strong signal and often marks the start of a lengthy trend. On very short-term charts it's maybe not as reliable because there's a lot of noise and false crossovers, but for longer-term charts from say 1 hour upwards, they can produce some outstanding signals.
I often use the ADX and directional movement indicators on the 1 hour charts for additional confirmation when using my main 4 hour trading strategy (see above for more details) and they've always been fairly reliable.