In the previous article that we published for your trading training we talked about Elliot waves and how they were formed. It may seem difficult to identify but we already taught you those tricks that you like so much to facilitate the interpretation of the graphs. In today's trading training, we return to technical indicators with one that can help us in these times of high volatility; the ADX. Let's see the secrets that this indicator hides...
What is ADX?
The ADX, or better known as Average Directional Index (Average Directional Index in Spanish) is an indicator that helps us determine when the price of an asset may enter a strong trend. Due to this quality, this indicator is one of the most precious to be able to optimally enter trends and generate good returns. Was created by J. Welles Wilder Jr. and yes, it is the same one that created the RSI, the indicator that we show you in this article trading training. This indicator allows us to identify the trend in which an asset is located or even give us signals to enter trends, whether bearish or bullish. It belongs to the class of oscillator indicators, that is, they move between values ​​from 0 to 100.
How does ADX work?​
The ADX indicator oscillates between values ​​between 0 and 100. It is used to measure the strength of a trend. The ADX is based on a moving average (blue line) based on price range expansions over a given period. Of course, it is not a directional indicator, since it measures the strength of trends regardless of whether the price goes up or down. To quantify the strength of the two trends, we can use it in conjunction with the Directional Movement Indicator (DMI), which represents the strength of buyers (green line) versus the strength of sellers (red line).
Chart with the composition of the ADX indicator. Source: Tradingview.
How to interpret the ADX
In order to trade with this indicator, we have to understand the function of the ADX and the relationship with the DMI. We can measure the strength of the ADX from 0 to 25 considering a weak trend, where periods of accumulation or distribution usually arise. From 25 to 50 can be considered a strong trend. By entering values ​​between 50 and 75, the trend increases its strength. From 75 to 100 is an extremely strong trend. One characteristic we have to observe to validate a trend is that the ADX remains in a range of values ​​for more than 30 bars.
ADX ranges help us identify the strength of a trend. Source: Tradingview.
Now that we know how to measure the strength of trends, let's see how to interpret the crosses and positions of the DMI with respect to the ADX.
How to interpret DMIs
DMIs at first glance may seem easy to interpret; a green line representing buying strength and a red line representing selling strength. But the truth is that we must know that there are certain characteristics to take into account. The DMI measure the strength of each side, therefore, in order to determine which of the two is in command, we must look at their positions. In turn, when we identify a DMI marking a sequence of decreasing highs, we can interpret that the trend is about to reverse. It can normally be seen when the ADX begins to correct its downward direction.
Interpretation of the ADX in a bearish movement. Source: Tradingview.
If, for example, we see that the DMI + is above the DMI-, it means that the buying force is predominant. It also influences what position each of the ADX lines are in. We can then identify crossovers that can be made between the DMI and the ADX. If the DMI- crosses upwards above the DMI+ and we see that the ADX follows its steps, it is a strong signal in favor of a bearish movement.
Is there any investment strategy in this trading training?​
In order to take advantage of this training in trading on the ADX, we are going to show you how to take advantage of the indicator to discover the strength that a trend may harbor:
Take advantage of bullish movements
To take advantage of bullish movements, it is advisable to wait to consider an entry the moment we see the DMI+ cross above the DMI-. Next, when it begins to rise above the level of 25, we confirm the strength of the signal, so we can safely enter the asset. The time to exit the open long position is when we see weakness in the DMI+ and ADX and in turn a rise in the DMI-. As we see in the chart below, at the moment the DMI+ crosses the DMI-, the ADX accompanies the movement to confirm the strength of the bearish trend.
How to take advantage of ADX and DMI in uptrends. Source: Tradingview.
Take advantage of bearish movements
To take advantage of bearish movements, it is advisable to wait to consider an entry the moment we see the DMI- cross above the DMI+. Next, when it begins to rise above the level of 25, we confirm the strength of the signal, so we can safely enter the asset. The time to exit the open short position is when we see weakness in the DMI- and ADX and in turn a rise in the DMI+. As we see in the chart below, the moment the DMI- crosses the DMI+, the ADX accompanies the movement to confirm the strength of the bearish trend. Curiously, this double crossover usually causes strong movements like the one we can see in this graph.
How to take advantage of ADX and DMI in downtrends. Source: Tradingview.
Conclusions from this trading training
After having finished this training in trading on the ADX indicator, we want to remember as always that the safest thing is to combine the indicator signals with other indicators. The ADX has taught us that we can measure the strength of a trend and in turn how DMI can help us facilitate the understanding of the strength of buyers and sellers. But we should not leave our trading operations at the mercy of a single indicator. We can use this indicator momentarily to get a signal about the strength of a trend, in addition to the signals from other indicators. As a recommendation, you can use the indicator ADX and DI from Tradingview to use ADX with DMIs.