Trading with ADX: Most profitable and least risky strategy is to trade with the Trend. The stronger the trend the better the reward is. Finding the trend, measuring its strength is possible with Average Directional Index (ADX), an indicator developed by Welles Wilder. It may be worth mentioning here that of Welder contribution to technical analysis was also in developing RSI, ATR and Parabolic SAR.
ADX indicator is used to find whether Stock is in trend and also finds the strength of the trend. It, however, does not indicate about the direction of the trend. It provides similar value for both uptrending and down-trending stocks. Stock direction is provided by additional lines that supplement with ADX. We will cover them later.
Though complex in calculating its value, its usage is very simple. Its value oscillates between 0 and 100. Wilder suggested that if ADX is above 25 then stock is trending and as the trend gets stronger, ADX moves up. A value above 40 is considered a very Strong uptrend. A value below 20 is considered as no trend or sideways market.O wing to its vast acceptance, most of technical Analysis software does the calculation including TopStockResearch.
ADX Value | Trend Strength | Comments | Stock Screener at TSR |
---|---|---|---|
0-20 | Non Trending | Sideways market or a phase of Accumulation/Distribution | Yes |
20-25 | Trending for less Volatile Stocks | Some Analysts use value above 20 as Trending. Works for lesser volatile stocks | Yes |
25-40 | Strong Trend | This indicates very strong trend. Traders should take advantage of it. | Yes |
40-60 | Very Strong Trend | Rare but they do occur | Yes |
60-100 | Extremely Strong Trend | Very rare. Such trends are not sustainable and traders should be ready for trend reversal | Yes |
Although it was developed for commodities, it can be used for stocks also. Since Commodities are more volatile, ADX would yield better results with more volatile stocks. For less volatile stocks, ADX value of above 20 could be considered as trending stocks. Standard period for calculation of ADX is 14 days. Some traders prefer to adjust between 7 to 28 days to suit their needs.
Where ADX line is represented as Green Color and oscillates between 0 and 100. Along with ADX lines, you would see directional Index +DI (Plus Directional Index) and -DI (Minus Directional Index) lines.
ADX is normally represented as a small chart below price chart as
Strong Trend: An increase in ADX value of above 25, means that trend is getting stronger and and provides better confidence to the trader.
Divergence: As mentioned earlier, divergence in ADX does not predict fall in price. As long as the value stays above 25, the trend is intact.
Change of Trend : ADX crossing below 25 signifies end of trend or movement in no trade zone.
Non-trending: ADX between 0 to 25 refers to a non trending zone.
Trade with Trailing Stop Loss: Since it indicates about the continuation trend only and not the ultimate target, it can best be traded with trailing stop loss or partial profit booking.
Directional Movement: While ADX provides information only about the strength of the trend, it is normally supplemented with Directional Index +DI and -DI. They indicates direction of the trend. Their interpretation is as follows:
1.When +DI is above -DI then trend is up trend.
2.When -DI is above +DI then trend is downwards.
3.+DI crossing over -DI signals bullish trend and vice versa.