ADX Oscillator - Technical Analysis

The ADX Oscillator's use in Technical Analysis

 

For share traders it often said “the trend is the friend”. Finding the trend of the stocks is the primary task of the trader or investor as this is the basic condition in share market. The trend can be upwards or downwards. The investor has to ascertain the trend of market and the stock. Once the trend is identified the next questions are how strong the trend and the direction. This becomes an important factor in trading because; it can reduce loss of money and increase profits.

While doing Technical analysis, there are many indicators available today to find the trend of any market. The Average Directional Index or ADX in short is one of them which has been  described here. 

The Formula for ADX is posted below

ADXi = [(ADX(i-1) * (n - 1)) + DXi] / n
where n = Smoothing Period
DX = [ 100 * ABS( (+DI) - (-DI) ) ] / ( (+DI) + (-DI) )

The ADX is an oscillator with values ranging from 0 to 100.depending on this value we can determine the true strength of a stock. A range of 0-20 indicates the absence of trend. 20-40 indicates the trend is very moderate. 40-70 range is considered a strong trend. 70-100 indicates that the stock is extremely strong trend. A stock may be in an uptrend, downtrend or in a sideways trend. The characteristic of ADX is it does not take the sideways movement of price of a stock as a trend.

Using ADX indicator 

The basic settings for ADX are simple and easy to remember. You may have noticed in the charts ADX(14). This denotes the period for which the ADX has been plotted. The default value of 14 is good and reasonable. Too long period can delay the entry points and too short period may give too many buy sell signals which may not be useful. The majority of traders would like to enter trade when the ADX rises above 20 to enter a trade. They also prefer to exit when the ADX falls below 40.  Some traders prefer to use ADX along with other indicators for entry and exit. I believe to exit a trade ADX is a good tool, because ADX is primarily a trend indicator, and when a weak trend is indicated it is good exit point.

In a chart we come across the ADX displaying three lines, ADX +DI, -DI. The DI means the Directional Index. When the +DI is above –DI we note the price is moving up. When –DI above +DI the price moves downwards.

There is one thing to remember here. Low ADX means the strength is weak and not the trend has come to an end.

The above chart explains the relationship of ADX and price action. Even during an uptrend the ADX moves down indicating the uptrend has a weaker strength. The ADX can show a weaker strength in a sideways market by moving down. We already know that ADX ignores a sideways market. When the strength returns to the market the ADX marks it with a higher value.

When ADX is lying below 20 and reverses, traders often see an opportunity for entry. When the ADX crosses 25 comfortably it is a confirmation of the strength of the uptrend. This could be even a breakout. Traders can wait till the 70 levels on the upper side is reached and take a call to exit. Following the ADX oscillator could bring immense benefits to a trader or investor, as loss can be minimized considerably.