ADX Indicator: How to Measure Trend Strength Before Entering

Many trading strategies work well in trends and poorly in sideways markets, or the other way around. The problem is knowing which of the two you are in before you enter. That is exactly what the ADX tries to answer.

What the ADX measures

The ADX (Average Directional Index) was created by J. Welles Wilder and measures the strength of the trend, on a scale from 0 to 100. It does not indicate direction: a high ADX can accompany both a strong rally and a strong decline.

Direction comes from two lines that usually appear with it:

• +DI (positive directional indicator): measures the strength of upward moves.
• -DI (negative directional indicator): measures the strength of downward moves.

When +DI is above -DI, buyers are in control. When -DI is above +DI, sellers are. The ADX shows how strong that control is.

How it is calculated, in general terms

In each period, the indicator compares the current high and low with those of the previous period. If the high rose more than the low fell, it counts as positive directional movement. In the opposite case, negative. These movements are divided by the period's true range and smoothed, usually over 14 periods, forming +DI and -DI.

The ADX is the smoothed average of the difference between the two lines relative to their sum. When one line moves far away from the other, the ADX rises. When they move together, the ADX falls.

How to read the levels

The levels below are market conventions, not strict rules, but they work as a starting point:

Just as important as the level is the slope. A rising ADX means the trend is gaining strength. An ADX falling from a high level means strength is fading, even if price is still moving in the same direction.

How to use it in practice

As a filter. This is the simplest and most useful use. Before following a trend strategy signal (a moving average crossover, a breakout), check the ADX. If it is below 20, the signal is more likely to fail and can be ignored.

To choose the strategy. A low ADX favors trading the extremes of a range with oscillators, such as the Stochastic or the RSI. A high ADX favors following the move and avoiding trades against it.

With the DI line crossover. +DI crossing above -DI with the ADX above 20 and rising is a classic signal for the start of an uptrend. The opposite crossover signals the start of a downtrend.

To manage the exit. When the ADX turns down after moving above 40, the trend may be near its end or a pause. It is a good time to protect profit by tightening the stop.

Limitations

• Lag. Because it is a smoothed average, the ADX confirms the trend after it has started. It is not meant to catch the exact start of the move.
• It does not show direction on its own. An ADX of 45 in a strong decline is a terrible reason to buy.
• News can distort the reading. A price jump caused by an economic release inflates the ADX for a few periods without there being a real trend.

What it is like on Safirion

You can apply the ADX to the chart of any of Safirion's more than 130 assets and adjust the period. A useful exercise is to mark, in the demo account, how many signals from your strategy occurred with the ADX below 20 and how many of them worked. That number often quickly shows how much money the filter saves.

Risk warning: Trading leveraged products involves significant risk of loss and may not be suitable for all investors. Technical indicators do not guarantee results. Trade only with capital you can afford to lose.