2020 Trend Strength Indicator – ADX Formula & Strategy
2020 Trend Strength Indicator
When trading, following the direction of a trend can lead to increased profits and reduction of downside risk. When looking at the strength of a trend, the average direction index, or ADX, is commonly used to determine how strong the trend is. In this article, we’ll take a deeper look into one of the most popular trend indicators and how you can incorporate it into your trading strategy to increase your profits.
There is a large variety of trend indicators that are easily accessible and available to traders. Because many of these indicators are very similar, the difficulty lies in finding the right trend indicator that suits your trading style and strategy. Before using a trend indicator when trading, it is highly recommended that you test and practice using the indicator.
What Are The Best Trend Indicators?
Popular trend indicators that we would recommend for trading include Moving Average Convergence Divergence (MACD), On Balance Volume (OBV), Relative Strength Index (RSI), and Average Directional Movement (ADX).
Moving Average Convergence Divergence, or MACD, is one of the most tried and tested trend indicators. The MACD can be found by subtracting the 26 period EMA from the 12-period EMA. This MACD that is calculated is then plotted on the same chart as a signal line, which is the MACD’s 9 day EMA. When the MACD intersects and rises above the signal line, this signals a bullish trend. When the MACD intersects and falls below the signal line, this signals a bearish trend.
On Balance Volume, or OBV, is another valuable indicator that factors in volume. OBV relies on a simple, underlying belief: trends should be confirmed by volume. The OBV is found by adding the volume of green days and subtracting the volume of red days.
Relative Strength Index, or RSI, is another extremely popular trend indicator among successful traders. Essentially, the RSI measures whether an asset has been overbought or oversold. The RSI is a particularly valuable indicator for determining whether trends may potentially reverse directions.
Average Directional Movement, or ADX, is one of the most powerful and accurate trend indicators. ADX measures how strong a trend is, and can give valuable information on whether there is a potential trading opportunity.
How Do You Determine The Strength Of A Trend?
The strength of a trend can be determined in several different ways. Through the use of volume and price data, various indicators can provide insight into both the direction and strength of the current price trend of the asset.
A powerful upward trend happens when the bulls are in control of the market, and is typically accompanied by strong volume and a large number of buy orders. Alternatively, a powerful downward trend occurs when the bears are in full control of the market, and is typically accompanied by strong volume and a large number of sell orders.
What Is Trend Strength?
Trend strength is the degree of power the bulls or bears have over the market. In a weak bullish trend, the bulls are in control of the market, but the bears are still bringing significant downside pressure. In a strong bullish trend, the bulls are in complete control of the market, and the bears are mostly waiting in the wings.
Trading in the direction of a very strong trend can potentially lead to low-risk and high-profit trades. Conversely, a weak trend can inspire false confidence and has a higher risk of reversing in the near future.
ADX Indicator Formula & Strategy
The ADX is calculated using a moving average of the change in the price range over a set period. While the most common setting for the ADX is 14 bars, a trader can adjust the setting to suit their personal preferences and trading strategy. The ADX indicator can be applied when trading virtually any large volume asset.
When plotted on a graph, the ADX is a singular curve that ranges from 0 to 100. The higher the ADX is, the stronger the trend is. ADX values of 0-25 typically signal a very weak or non-existent trend, while an ADX of 25-50 suggests that there is a concrete trend. An ADX value between 50-75 suggests that the trend is very solid, while an ADX value of over 75 is indicative of an especially strong trend.
When using ADX it is important that you first judge the price of the asset and how it is moving. If there looks to be a potential trading opportunity, the trader should use ADX to determine whether or not there is a trend in a certain direction, along with a strength of the trend.
When there is price uncertainty in the market, with bulls and bears pushing the prices in opposite directions with strong volume, there will often be a price breakout that follows. Price breakouts that result from these situations often trend strongly in the same direction immediately after the breakout. When judging the strength of a breakout, it is often useful to use ADX to determine the strength of the breakout–anything above a value of 25 is usually good enough to indicate that the trend from the breakout will continue in the short term.
ADX can also be used to determine when the current trend is weakening and due for a possible reversal. When a trend is about to reverse upwards, this represents a potential long opportunity for a trader. When a trend is about to reverse downwards, this represents a potential short opportunity for the trader.
Is ADX A Good Indicator?
ADX is a powerful indicator when used correctly. As with all technical indicators, it should not be used as the primary basis for a trade. First, a trader should look for a trading opportunity using other techniques, such as patterns, and then utilize the ADX to confirm that the trade follows the current trend of the market.
When trading, following the most defined trends can lead to very high profits with low downside risk. ADX works to indicate the strength of a trend and allows the trader to identify the key opportunities when the trend is extremely strong. Additionally, the ADX also helps the trader avoid situations where there isn’t a clearly defined trend and the price may move in either direction and through this, also helps the trader to limit risk.
How Do I Learn ADX Indicators?
When learning how to use ADX indicators, it is important to keep in mind that the indicator only suggests that there may be a strong trend when the ADX is above 25. For anything lower than that, the ADX suggests that there isn’t a concrete trend and the price may move in either direction.
When learning to use ADX, it is often useful to include it into your normal screening methods or trading checklist. While the ADX doesn’t provide the trader with concrete buy or sell indications, the ADX does give a good perspective on how the stock may move in the future.
How Is ADX Indicator Calculated?
When calculating the ADX, the directional movements, or DM, should first be calculated. The +DM is calculated by first subtracting the period’s high by the previous period’s high, known as the up move. The -DM is calculated by first subtracting the period’s low by the previous period’s low, known as the down move. If the up move is larger than the down move, +DM is equal to the up move and -DM is equal to zero. If the up move is smaller than the down move, +DM is equal to zero and -DM is equal to the down move.
The +DI, or the positive directional indicator, is found by multiplying the EMA of the +DM value by 100 and dividing this value by the 14-period average true range. The -DI, or the negative directional indicator, is found by multiplying the EMA of the -DM value by 100, and dividing this value by the 14-period average true range.
Finally, the ADX is calculated by multiplying the EMA of the absolute value of the difference of +DI and -DI by a value of 100.
The DMI, or directional movement indicator, was originally conceived by J. Welles Wilder Jr., the creator of the tried and tested RSI.
When plotting the DMI, the +DMI, or positive directional movement indicator, is plotted against the -DMI, or negative directional movement indicator. The +DMI reflects the strength of the bulls, while the -DMI reflects the strength of the bears. When the +DMI line is over the -DMI line, the indicator suggests that the bulls have more control of the market. When the -DMI line is over the +DMI line, the indicator suggests that the bears have control over the market. The DMI line that is higher is referred to as the “dominant” DMI.
The DMI is different from the ADX in that it also signals trend reversals. When one of the DMI lines crosses over the other, the DMI suggests that the trend may be reversing into the direction of the now dominant DMI.