Beginner's Guide To The Average Directional Index (ADX)


By @savdoescrypto


The Average Directional Index (ADX) is used to gauge trend strength. Originally designed for commodity markets, the ADX is a strategy selection filter to provide insights into when a trend could be coming to an end.

This short guide is designed to cover the basics necessary to begin using the ADX in your trading in no more than 2 minutes.

Summary

  • The ADX measures the strength of a trend, not its direction.

  • A trend is considered strong when the ADX is above 25

  • A reading below 20 indicates that the trend is weak or trend-less.

  • It is best used as a filter for trend-following strategies

How To Use The ADX Indicator

Step 1: Open a chart on the BTSE platform


Step 2: Click the “Indicators” tab or push the “/” key


Step 3: Select “Average Directional Index” from the drop-down menu


Step 4: Admire your newly plotted ADX indicator


How To Trade Using The ADX Indicator


In general:

  • A trend is considered as having strength when the ADX is above 25.

  • A reading below 20 indicates that the trend is weakening or trend-less.


As you can see, the ADX measures the strength of the trend, not its direction. Therefore, an ADX reading above 25 can indicate the strength of both a bullish trend and a bearish trend - i.e. it depends on which way the price is going.

The ADX is best used in conjunction with other directional indicators as a filter. In particular, traders might rely on the ADX to switch between trading strategies.

As their name would suggest, many trend-following strategies perform best in a trending environment. Conversely, mean-reversion strategies generate the best results when the market is trend-less.

For example, using the ADX as a filter, a trader might use a trend-following moving average strategy when the ADX is over 25 and a mean-reverting RSI strategy when the ADX is below 20 and the trend is weak or trend-less.

Alternatively, traders might use the ADX to determine turning points in the market. To do this, we can combine the ADX with a simple moving average (SMA) to generate the following signals:

  • Buy in a pre-existing bearish trend when the price crosses from below to above the 50 day SMA only when the ADX is below 20.

  • Sell in a pre-existing bullish trend when the price crosses from above to below the 50 day SMA only when the ADX is below 20.


This strategy only attempts to pick a turning point when the ADX indicates that the trend growing weaker.


See below for a cherry-picked example of this strategy:



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