Forex traders use multiple technical indicators when analyzing markets. Some indicators measure volume, others overbought and oversold conditions, volatility, etc. Each indicator should be used in a specific situation to get a productive outcome.
The average directional index, or ADX, is one of such indicators. ADX Forex indicator measures the strength of a trend on a scale from 0 to 100 to assess whether the trend is likely to turn upwards or downwards.
ADX indicator overview
ADX indicator in FX is an indicator that measures the strength of any prevailing market trend, regardless of its price direction. One of the most frequently used technical indicators, ADX is a reliable tool for trend traders that provides valuable insight into the price momentum of a given instrument to gauge whether there is a significant trend forming or not:
- ADX is a lagging directional movement indicator that measures the strength of a trend on a scale of 0 to 100
- FX ADX indicator is most often used alongside the directional movement index (DMI), which includes two other lines – positive and negative directional indicators, -DI and +DI
- ADX is also used in strategies alongside the MACD indicator
- The indicator is placed below the chart to not impede visibility and measures the price movements on the chart by an appropriate strength value of 0 to 100
- ADX is most suitable for use in daily charts
- The default number of periods used by ADX is 14
- Forex trading ADX indicator measures the strength of a trend, not the direction
Technical details of the ADX indicator
ADX indicator for FX trading is plotted along the price chart and measures the trend strength across the chart. This serves as an important tool to find out when the momentum is the strongest, to identify the reasons behind the price shifts.
ADX is followed by two directional indicators plotted alongside a directional movement index. When the negative and positive directional indicators cross, it can signal a changing trend:
- If the +DI crosses the -DI at an ADX above 25, this can signal the start of an uptrend
- If the -DI crosses the +DI at an ADX above 25, this can signal the start of a downtrend
Calculating the ADX indicator in Forex trading is not a straightforward process and involves multiple steps. The first step is to calculate the positive and negative directional movements as follows:
- Calculate the true range, +DM and -DM for each period
- The resulting values need to be smoothed using Wilder’s smoothing technique
- Divide the 14-day smoothed +DM by the smoothed 14-day true range to find +DI14. Multiply the result by 100
- Divide the 14-day smoothed -DM by the smoothed 14-day true range to find -DI14. Multiply the result by 100
- The absolute value of +DI14 minus -DI14, divided by their sum and multiplied by 100 is the value of the directional movement index, or DMI
- The last step is to calculate the ADX line. The first ADX value is equal to a 14-day average of the DMI. Subsequent ADX values are smoothed by multiplying the value of the previous 14 days by 13, adding the last DMI value, and dividing the sum by 14
What does ADX show?
ADX values show traders the most profitable points for them on a price chart. While the market may be constantly changing, a lot of false breakouts can happen, which can distort the decision-making process of traders. ADX shows the momentum behind trends to distinguish actual strong trend formations from weak ones. In general, four ADX levels can be observed based on their value from 0 to 100:
- ADX between 0 and 25 shows a very weak trend that has a high likelihood of a false breakout
- ADX between 25 and 50 shows moderate trend
- ADX between 50 and 75 is considered to be a very strong trend
- ADX between 75 and 100 is considered to be the strongest, with a high likelihood of an actual breakout
Practical application of the ADX indicator
To look at ADX in action, we can look at the ADX indicator example. Most trading platforms and third-party charting software will have ADX and other technical indicators readily available, so traders do not have to calculate them manually.
Let’s look at an example of ADX in the EUR/USD pair:
ADX on the chart shows the positive and negative directional indicators. The higher end of the +DI ranges between 50 and 55. This is not unusual for major pairs with relatively scarce news releases throughout the day. The highest values are often visible when major economic news reaches the market, which can prompt millions of traders to alter their strategies.
The YTD chart of the same pair shows the highest values during times when the two currencies reached parity, with the euro later dropping below the dollar, which also signaled a changing trend.
History and other useful details of the ADX indicator
The ADX indicator was developed by J. Welles Wilder, who is also known for authoring the relative strength index (RSI), Parabolic SAR and average true range – all being indicators that are widely used in technical analysis today.
Wilder developed the index in 1978 and is one of the most frequently used lagging indicators used by traders.
FAQs on the ADX indicator
What is the best time frame for ADX indicator?
The best time frame for most technical indicators used in trend trading is a single day. Daily charts are easily observable and less convoluted than those of longer time frames. ADX is used on daily charts alongside the directional movement index (DMI).
What is ADX indicator formula?
To calculate the ADX value of a specific period from the standard 14 periods, multiply the prior ADX value by 13 and add the current directional index value. Divide the sum by 14, which will give you the ADX value of a single period.
Is ADX indicator good for forex traders?
ADX is a useful indicator for forex traders that helps identify strong trends and avoid false breakouts. ADX works well with other technical indicators, such as MACD and DMI, and is often used by day traders.