This is the second article in our ADX series. If you haven’t already we suggest that your check out the first article about the ADX Indicator. In that article, we covered the history of the “Average Directional Movement Index”, or “ADX”, indicator, how it is calculated, and how it looks on a chart. The ADX indicator will typically have three lines, one each for measuring descending and ascending trends (referred to as “DM” or Directional Movement lines), and then the “signal” line that represents the “absolute” force of either the ascending or the descending trend.
A trader must remember that the ADX “signal” line is an “absolute value”, always a positive number measuring the strength of either a positive or negative trend. The ADX is often used to determine the potential for market changes depending on the movement of values. If the ADX moves over 20 points from its lower values, then attention is given as it approaches the 40 line. Trading signals are generated at peaks in the ADX or crossovers of the two minor DI lines. A weakness of this oscillator is that many of the crossovers can be false signals if the currency pair is moving in a sideways fashion.
How to Read a ADX Chart
The ADX with a standard period setting of “14” is presented on the bottom portion of the above “5 Minute” chart for the “GBP/USD” currency pair. In the example above, the “blue” line is the ADX, while the “green” line represents ascending directional movement and the “gold” line, descending. ADX values below 20 are weak trends and strong trends are over 40. Particular attention is the rule when the ADX oscillator moves upward more than 20 points from the lower regions.
The key points of reference are high points and line crossovers. Special significance is suggested when a crossover is accompanied by an upward thrust of two indexes. As with any technical indicator, an ADX chart will never be 100% correct. False signals can occur, but the positive signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding ADX signals is developed over time.
In the next article on the ADX indicator, we will put all of this information together to illustrate a simple trading system using this ADX oscillator.
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