Trading With the ADX Indicator

Admirals Mar 26, 2024 11 Min read

This article will explain what the ADX indicator is, it will cover the Forex ADX indicator calculation in detail, it will take a look at the advanced Forex ADX indicator for MetaTrader 4 and MetaTrader 5, it will explain how to read the ADX indicator, how to measure trend strength, and much more!

Some of the most powerful trading strategies revolve around following market trends. There are also strategies that seek to profit from the market, by trading counter to the trend. If you are able to correctly identify when a trend is forming, you will be stacking the odds in your favour.

Just as useful is the ability to gauge the strength of a trade. There are a variety of indicators that attempt to do this. The ADX indicator is one such tool. It was developed by J. Welles Wilder, who also invented other extremely popular technical indicators such as:

What is ADX?

The Average Directional Index (or ADX indicator) is a technical tool designed to measure the strength of a market trend. The ADX indicator is used for various purposes, such as measuring trend strength, as a trend and range finder, and as a filter for different Forex trading strategies.

Forex ADX Indicator Calculation Explained

The ADX technical indicator is derived from two of Wilder's directional indicators:

The positive directional indicator (+DI)
The negative directional indicator (-DI)

These indicators complement the ADX by providing a guide to the trend's direction, and they come from quite simple measures of the market's directional movement. They define directional movement by comparing the high and low of the current period with the high and low of the previous period. Wilder defined two terms that help here:

Plus directional movement (+DM)
Minus directional movement (-DM)

Directional movement can either be positive, negative, or zero. It cannot be both positive and negative, and it is either up or down. So when the +DM has a value other than zero, the -DM is zero. And when the -DM has a value other than zero, the +DM is zero. Directional movement is positive when the current high minus the previous high is both positive and greater in value, than the current low minus the previous low.

Negative directional movement is defined in a similar way. Directional movement is negative when the previous low minus the current low is both positive and greater in value, than the previous high minus the current high. When the +DMI is above the -DMI, prices are moving up and the ADX measures the strength of the uptrend. When the -DMI is above the +DMI, prices are moving down, and the ADX measures the strength of the downtrend.

For traders, the good news is that modern trading software performs these calculations for you automatically. The standard MetaTrader 5 platform comes with the ADX indicator included, so there's no need for a separate ADX indicator download.

Click the banner below in order to download MetaTrader 5 for free!

The Advanced Forex ADX Indicator for MetaTrader 4

Once you have installed MetaTrader 4 on your device, you will see a much more advanced ADX technical indicator compared with what Wider originally proposed. This is because the MT4 ADX uses slightly different auto-smoothing techniques that provide a more precise but less smooth graph. The chart below shows the Average Directional Movement Index as the first item on the list of trend indicators. Simply drag and drop onto the chart, as the GIF below demonstrates:

Depicted: MetaTrader 4 - EUR/USD Hourly Chart - Admirals Platform - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

If you select 'ADX', MT4 will prompt you to enter a value for the period. You can also change the colours in the indicator itself to match the colours displayed on the charts here. You can do that in the indicator properties, as shown in the screenshot below:

Source: MetaTrader 4 - Changing colours for the ADX Indicator

The default value is 14, and the standard way of depicting the ADX is to show three lines below the main price chart. These lines include a thick light-blue line for the ADX itself, a green dotted line for the values of +DI, and a red dotted line for the values of -DI. Software packages will usually plot values for +DI and -DI alongside the value of the ADX.

Depicted: MetaTrader 4 - EUR/USD Hourly Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

How to Read the ADX Indicator

By now, you hopefully understand that the advanced ADX indicator is used to show you whether or not the market is trending. But how do we know when a trend occurs? Basically, the ADX ranges between 0 to 100. Wilder considered a value above 25 to suggest a trending market, whereas a value below 20 suggests that there is little or no trend. But as you can see, these values leave you in limbo between 20 and 25. For this reason, many modern technical analysts use 25 as the key demarcation point between 'trend' and 'no trend'.

Measuring Trend Strength

Wilder's ADX directional system can also gauge the change in market sentiment by tracking changes within the price range. By reading the ADX line, we can measure an underlying trend strength. For instance, according to Investopedia:

If the ADX value is between 0-25 - the trend strength is regarded as absent or weak
If the ADX value is between 25-50 - the trend strength is considered to be strong
If the ADX value is between 50-75 - the trend strength is very strong
If the ADX value is between 75-100 - it is an extremely strong trend

You can add these levels manually within the indicator properties. The screenshot below demonstrates how to perform this action in Metatrader 4:

Source: MetaTrader 4 - Setting levels manually for the Average Directional Movement Index (ADX) indicator

Trend and Range Finder

As we can see, the ADX shows when the trend has weakened and is entering a period of range consolidation. Range conditions exist when the ADX drops from above 25 to below 25. We can also see two dotted lines. The blue (+DI) and the red (-DI). If the +DI line is above the -DI line, it suggests a bullish trend. Conversely, if the -DI line is above the +DI line, it suggests a bearish trend. The strength of that trend is reflected in the ADX line.

Now, here's how Wilder suggests you to interpret this indicator's info: Wilder stated that when the ADX line rises, it suggests that the trend is strengthening, so you should trade in the direction of whichever DI line is higher. If the blue line is above the red line, it means that the bullish trend is dominating, and vice versa. Thus, with the ADX, you can measure both trend strength and trend direction. Take a look at the chart below, which shows a strong bullish daily trend:

Depicted: USD/CAD Daily Chart - MetaTrader 4 - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Filter for Different Forex Trading Strategies

The ADX can also be used in different Forex trading strategies. Here is an example of an ADX trading strategy that we can use for trading the Forex markets. The strategy is also complemented by the MACD indicator, which uses different settings from the default one. You should also download MT4SE in order to obtain the Admiral Pivot indicator.

Time frame: Daily
Pairs: EUR/USD, GBP/USD, AUD/USD, USD/CHF, GBP/JPY, EUR/JPY, NZD/USD, USD/CAD
Indicators: MACD(3,10,18), ADX (18 with blue +DI and red -DI)

Buy trade:

The MACD crosses above the 0 line
The ADX blue (+DI) line is above the red (-DI) line
If the ADX light green line is above 25, it indicates a strong trend (continuation possible)

Sell trade:

The MACD crosses below the 0 line
The ADX blue (+DI) line is below the red (-DI) line
If the ADX light green line is above 25, it indicates a strong trend (continuation possible)

Depicted: GBP/USD Daily Chart - MetaTrader 4 Platform - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Targets are measured by trailing stops and the stop-loss is a maximum of 2% risk per trade, or whatever the risk you might deem appropriate.

Conclusion

As with so many 'look-back' trend measures, the ADX is a lagging indicator. This means that it will not indicate a trend until after one has occurred. The ADX indicator is included in the basic MetaTrader 4 and MetaTrader 5 packages, so there is no need to download it separately. Make sure to check out our articles & tutorials, if you would like to gain further insight into Forex and CFD trading.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of, or recommendation for, any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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