ADX indicator. Traders make money when price begins trending, up or down, from one price level to another. The challenge has always been to determine when price is breaking out of a trading range and solidifying into a trend, versus a brief move out of the range only to revert back to the mean.
An effective tool for spotting trends early on is the ADX Indicator. The creator of the ADX, Welles Wilder, cannily used different varieties of moving averages to arrive at the ADX algorithm. In fact it pays to know a bit about how the ADX works in order to most effectively use it.
The Average Directional Index (ADX) is a technical indicator that uses the Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI) to visually show a group of directional movement indicators that can be used as a trading system and was invented by Welles Wilder. Mr. Wilder created the ADX to focus on the daily prices of commodities this technical indicators can also be used in the stock market.
Positive and negative directional movement is the foundation of the Directional Movement System. Wilder used the ADX to determine the direction of the movement by measuring the difference between two consecutive lows with the difference between their respective highs.
The Plus Directional Indicator (+DI) and Minus Directional Indicator (-DI) are derived from smoothed averages of these differences and measure the direction of a trend over time. These two indicators are often collectively referred to as the Directional Movement Indicator (DMI). read more … How Does the ADX Indicator Work?
So knowing this about the +DI, the -DI, and the DMI, then suggests the approach to using it to capture trends.
As is probably obvious the DMI doesn’t indicate direction, but it does indicate a trend is under way and the shows the intensity of that trend. On the other hand the +DI and -DI do indicate the direction of the trend based on which is increasing while the other is decreasing.
That may sound a bit confusing, though it is straightforward once you’re familiar with it. Nevertheless, the video below shows you how to use the components of the ADX Indicator to catch trends early. (***note: Even though he talks about day trading, it applies to any time frame you’re trading on.)
To get the greatest value out of the ADX indicator it should be supplemented with another indicator or price levels to confirm the signal. By itself the ADX is prone to false signals.
The video suggested On Balance Volume, which was quite creative. Though often, the price action reveals all you need. e.g. Drawing support and resistance lines above and below the trading range coincides with the ADX activity below the 25 line. When breaks out and closes outside the range, you find the ADX breaks above the 25 line just as volatility begins to expand and price takes off.
The ADX indicator is a very handly tool.