The Average Directional Index, or ADX for short, is another
example of an oscillator. It fluctuates from 0 to 100, with readings below 20
indicating a weak trend and readings above 50 signaling a strong trend.
Unlike the stochastic, ADX doesn't determine whether the trend is
bullish or bearish. Rather, it merely measures the strength of the current
trend. Because of that, ADX is typically used to identify whether the market is
ranging or starting a new trend.
Take a look at these neat charts we've pulled up:
In this first example, ADX lingered below 20 from late September
until early December. As you can see from the chart, EUR/CHF was stuck inside a
range during that time. Beginning in January though, ADX started to climb above
50, signaling that a strong trend could be waiting in the wings.
And would you look at that! EUR/CHF broke below the bottom of the
range and went on a strong downtrend. Ooh, that'd be around 400 pips in the
bag.
Book it, baby!
Now, let's look at this next example:
Just like in our first example, ADX hovered below 20 for quite a
while. At that time, EUR/CHF was also ranging. Soon enough, ADX rose above 50
and EUR/CHF broke above the top of its range.
Tada!
A strong uptrend took place. That'd be 300 pips, signed, sealed,
and delivered!
Looks simple enough, right?
If there's one problem with using ADX, it's that it doesn't
exactly tell you whether it's a buy or a sell. What it does tell you is whether
it'd be okay to jump in an ongoing trend or not.
Once ADX starts dropping below 50 again, it could mean that the
uptrend or downtrend is starting to weaken and that it might be a good time to
lock in profits.
How
to Trade Using ADX
One way to trade using ADX is to wait for breakouts first before
deciding to go long or short. ADX can be used as confirmation whether the pair
could possibly continue in its current trend or not.
Another way is to combine ADX with another indicator, particularly
one that identifies whether the pair is headed downwards or upwards.
ADX can also be used to determine when one should close a trade
early.
For instance, when ADX starts to slide below 50, it indicates that
the current trend is losing steam. From then, the pair could possibly move
sideways, so you might want to lock in those pips before that happens.
