ADX Indicator - How To Use ADX
Trend Indicator

The adx indicator is best known as a trend indicator as it can identify when a stock is trending. ADX stands for Average Directional Index. Used in a stock screen, ADX can help to quickly identify trending stocks. This webpage will help traders and investors learn how to use adx.

A rising adx indicator line tells the trader that the strength of the trend is rising and price is moving with the trend. A falling ADX trend indicator means the strength of the trend is decreasing and price is likely consolidating (i.e. trading in a horizontal trading range) or retracing (i.e. dropping in price but not trending). It's important for all traders and investors to know how to use adx.

For most investors and traders, there are two important market conditions of importance:

  1. Is the market trending upward
  2. Is the stock trending upward

Common to both questions are four additional qualifying questions:

  1. Is there a trend?
  2. What is the direction of the trend?
  3. How strong is the trend?
  4. Is the trend just beginning or is it coming to an end?

Note: Many traders will say that stocks are always trending. They're either trending upward, downward, or sideways. In the context of the ADX indicator, stocks only trend higher or they trend lower. ADX does not consider sideways trading action as a trend.

ADX is one of the more popular indicators. It can assist in answering the above questions. A high ADX reading (i.e. >25) indicates the presence of a trend. A low ADX reading (i.e. <20) indicates there lack of a trend. Be aware that the ADX indicator by itself does not indicate the trend direction.

ADX is based on moving averages over a period of time. The DI Period (default period of time) is 14 bars but other settings can be used. Using a daily chart, ADX(14) means the ADX is based on 14 days. Swing traders, because they are dealing with shorter periods of time might use fewer bars (e.g. 10).

The strength of the trend generally follows the following criteria:

ADC Rating

Description

Between 0 and 20

No trend exists (do not trend trade)

Between 25 and 30

A trend is forming

Between 30 and 50

A strong trend exists

Above 50

A very strong trend may begin to weaken

Keep in mind that a falling ADX doesn't mean the trend has ended. It only means the strength of the trend is becoming weaker.

Look at sample chart below:

  • This is a stock that has been trading sideways in a trading range.
  • While in the trading range, the ADX was below 20 and briefly moved up to 23.
  • Then the price began moving upward
  • Shortly thereafter, the ADX moved above 25 and continued upward
  • Once the ADX indicator moved above 25, we can definitely see from the price chart that this stock was then trending upward.

Let's look at the same price chart only we'll look over a longer period of time.

  • The left side of the chart below is the same chart we saw above.
  • The stock price continued to trend upward and strengthen as the ADX moved up to a high of 32.
  • Then we saw the stock price begin to move sideways and the ADX began to drive downward. Notice that the price action did not move downward even though the ADX showed the trend was weakening.
  • For a short term, the price began to move upward and the ADX moved upward as well but didn't move above 25.
  • At the far right hand side of the chart we now see that the price began to drift sideways and the ADX showed a continually weakening trend indication. The ADX eventually dropped below 20 at which time we could say there was no trend.

Note: I need to emphasize the importance of understanding that a decline in the ADX does not mean a decline in the price of the stock. That is evident in both of the areas on the chart below where the price action drifted sideways.

Momentum Of The Trend

Peaks in the ADX can also provide some valuable information about the momentum of the trend. For example:

  • When looking for trends in an upward trending stock, we look for price to exhibit higher highs and higher lows. This is similar to higher ADX highs that indicate an increase in momentum. Increasing momentum provide strong evidence that the trader should stay invested in a stock because the trend has not ended.
  • When looking for trends in a downward trending stock, we look for price to exhibit lower highs and lower lows. This is similar to lower ADX highs that indicate a declining momentum for the stock.
  • Lower highs in the ADX indicator is a warning, not a sell signal. Lower ADX highs, yet with ADX above 25, can still result in an upward trending stock price.

Direction of the Trend

As mentioned above, ADX by itself does not indicate the direction of the trend. Some charting software will display three lines: ADX, +DI, and -DI. DI is short for Directional Index. Some traders pay a great deal of attention to the Directional Index lines, others tend to ignore them. That's a matter of personal preference based in part on the type of trading you are doing.

More about the Directional Index lines. When the +DMI is above the -DMI, prices are moving up, and ADX measures the strength of the upward trend. When the -DMI is above the +DMI, prices are moving down, and ADX measures the strength of the downward trend.

Screening For Trending Stocks

ADX is often used in scanning for stocks that are trending upward. However, many traders will not use ADX as a buy signal. They'll use other factors to determine whether a buy is in order. But it is helpful to know that the stock is in a strong trend and the ADX can help with that. The presence of a strong trend can reduce risk and increase profit potential in a trade.

Breakouts

When trading, always give greatest consideration to the price action in a stock. However, price by itself can be misleading when looking at a breakout to the upside or a breakout to the downside. Consider these examples:

  1. Breakouts often present a false signal. An apparent breakout can often reverse itself. That can be very frustrating to the trader that bought a stock when it broke out above resistance, only to have it fall back down below resistance. ADX can be helpful by showing that the upward trend is strong enough for the price to maintain its upward momentum after the long side breakout. This is indicated with an ADX moves above 25 and is moving higher.
  2. Reversals after a retracement in a long term upward trending stock generally signal a return to an upward movement in the price action. However, a reversal can also present a false signal. At some point in time, the longer term trend will end and the appearance of a reversal from a retracement may be misleading and the stock will move to a lower low thus ending the upward trend. ADX will indicate an end of the longer term trend when it drops from above 25 to below 25.

Summary

The adx indicator is best known as a trend indicator as it can identify when a stock is trending. Some of the most profitable trading opportunities come from trading in the presence of the strongest trends. Used in a stock screener, ADX can help to quickly identify trending stocks making this a very powerful tool. This webpage has provided you with important information on how to use adx.

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