ADX or Average Directional Index in Forex is a popular technical analysis indicator that helps traders identify the strength and direction of a trend. Developed by J. Welles Wilder Jr. in 1978, ADX is one of the most reliable indicators used by traders to make informed trading decisions. In this article, we will discuss the ADX indicator in Forex in detail, including its calculation, interpretation, and practical applications.
ADX Calculation
The ADX indicator is calculated based on a series of mathematical formulas that involve three lines: +DI, -DI, and ADX. +DI (positive directional indicator) and -DI (negative directional indicator) are plotted based on the price movement in the current trend. The ADX line is then calculated based on the difference between +DI and -DI.
The calculation process involves several steps. First, the +DM (positive directional movement) and -DM (negative directional movement) are calculated based on the high and low of the previous period. The +DM is calculated by subtracting the previous period’s high from the current period’s high. If the result is positive and higher than the previous period’s -DM, +DM is used. Otherwise, +DM is set to zero. The -DM is calculated in the same way, but the difference is between the low of the previous period and the current period’s low.
Next, the true range (TR) is calculated based on the high and low of the current period and the previous period’s close. The highest value of the three is used as the TR. Then, the average true range (ATR) is calculated by taking the average of the TR over a specified period. Finally, the +DI, -DI, and ADX lines are calculated based on the following formulas:
+DI = (Smoothed +DM/ATR) x 100
-DI = (Smoothed -DM/ATR) x 100
ADX = (Smoothed DX/ATR) x 100
Where DX = (Absolute value of +DI – Absolute value of -DI) / (Absolute value of +DI + Absolute value of -DI)
The smoothed values are calculated based on the smoothing period used by the trader. The most common smoothing period used for the ADX indicator is 14 periods.
ADX Interpretation
The ADX indicator is plotted on a scale of 0 to 100, with higher values indicating a stronger trend. The ADX line itself does not indicate the direction of the trend but only the strength. The +DI and -DI lines are used to determine the direction of the trend. When the +DI is above the -DI, it indicates a bullish trend, and when the -DI is above the +DI, it indicates a bearish trend.
When the ADX line is below 20, it indicates a weak trend or a range-bound market. Traders should avoid trading during this period as the market is not showing a clear direction. When the ADX line is between 20 and 40, it indicates a developing trend. Traders should start looking for trading opportunities during this period. When the ADX line is above 40, it indicates a strong trend. Traders should look for opportunities to ride the trend or consider taking profits if they have already entered the market.
Practical Applications of ADX Indicator
The ADX indicator has several practical applications in Forex trading. The most common application is to identify the strength and direction of the trend. Traders can use the ADX indicator to confirm the trend before entering a trade. When the ADX line is above 20 and rising, it indicates a developing trend. Traders can use this information to enter a trade in the direction of the trend.
Another practical application of the ADX indicator is to identify trend reversals. When the ADX line has been rising for a while and then starts to fall, it indicates a possible trend reversal. Traders can use this information to exit a trade or consider taking profits.
The ADX indicator can also be used in conjunction with other technical analysis indicators to confirm trading signals. For example, if a trader sees a bullish candlestick pattern and the ADX line is also rising, it provides additional confirmation of a bullish trend.
Conclusion
In conclusion, the ADX indicator is a powerful tool that helps traders identify the strength and direction of the trend. Traders can use this information to make informed trading decisions and improve their profitability. However, traders should keep in mind that the ADX indicator is not perfect and should be used in conjunction with other technical analysis tools to confirm trading signals.
