ADX

The speaker provides an overview of the ADX indicator and also discusses the components of this indicator: ADX line, -DI line, and +DI line.  He stresses that the indicator does not provide direction of trend; rather, it provides the strength of the trend. 

ADX reading below 20 are characteristic of trending, or sideways markets.  It is also typical for trending markets to have ADX readings above 40.  The ADX is a useful indicator in keeping traders out of rangebound action.

Traders use this indicator to indicate the kickoff of a new trend.  The longer a market has been in a range prior to the ADX breaking above 20, the more upside potential of the trade.  Traders also use the ADX as a signal for a trend reversal when the ADX is above 40 and then crosses below both the -DI and + DI lines.  Finally, the speaker mentions a strategy known as the DI crossover.  When the +DI crosses above the -DI, traders will look to go long the market and when the +DI crosses below the -DI, traders look to go short the market.

Transcript of How to Trade the Average Directional Index (ADX)

Introduction to ADX

Hi folks David Waring here again with informedtrades.com and today's lesson of the day. In our last lesson we learned about Bollinger Bands and how traders use these in their trade. In today’s lesson we are going to learn about the average directional Index or ADX for short, an indicator which helps traders determine whether the market is trending or not, how strong that trend is and whether the market may be switching from a trend to a range or vice versa. So, let’s get started

ADX - Trending and Range Bound Values

Okay, so here's what the ADX indicator looks like when it is plotted on a chart and as you can see it's made up of three lines. I am not going to go into the exact formulas for each line if you're interested in that I have posted a link. If you are watching this video on You Tube or one of the other video sites in the description section just below the video of if you are watching it on informedtrades.com with a much more in-depth explanation of all the formulas behind the indicator. But, what I feel is important to note is that the ADX line is composed of the two other indicators which are known as the positive directional Index or plus DI line for short and the negative directional Index which is the negative DI line for short. So, here's the ADX line in black the minus DI line in red and the plus DI line in green. The plus DI line is representative of how strong or weak the uptrend in the market is or another way of saying that would be how strong or weak the buyers in the market are. The minus DI line is representative of how strong or weak the downtrend in the market is or another way of saying that obviously is how strong or weak the sellers in the market are. As the ADX line is comprised of both the plus DI line and the minus DI line it doesn't indicate whether the trend is up or down but simply the strength of the overall trend of the market. One of the unique things and one of the reasons why I really like this indicator is it paints a really nice picture of both the buying pressure and the selling pressure as two different lines and then gives you one line which gives the overall strength of the underlying trend. When the ADX line is above 40 and rising, this is indicative of a strong trend and when the ADX line is below 20 and falling this is indicative of a ranging market. So, you can see here is below 20 and the market is ranging there and there is above 40 and the market is trending strongly, and some people will put that just for your knowledge, some people put the 40 number at 30 for the strong trend. Some people say you can start looking to trade trends above 25. There is a lot of debate as to what's the best number to use there, but anyways one of the first ways that traders will use the ADX in their trading is as a confirmation of whether or not a financial instrument is trending and to avoid choppy periods in the market, where many may find it harder to make money. In addition to a situation where which we are looking at now where the ADX line would be trending below 20 the developer of the indicator recommends not trading a trend of a strategy when the ADX line is below both the positive DI line and the negative DI line even if the ADX line is above 20. So, here you see a situation where you want to avoid trend strategies or maybe avoid the market altogether because the ADX line is below both the positive DI line and the negative DI line. There and you can see there's not much action in the market at all at that point. Another way traders use this indicator is to identify the potential start of a new trend in the market. Very simply here, they will look for a move of the ADX line from below the 20 line to above the 20 line as a signal that the market may be beginning a new trend. The longer the market has been in a range here normally traders will, when they see that move above the 20 line the longer the market has been in a range before that point the greater significance they are going to place upon that as a signal. So, you can see here is a chart of Goldman Sachs, there is a couple months of just real dead range in the market and then you have a break above 20 and then you have a good trend that results after that. Now obviously you are going to want to confirm with other things as there is no sure thing in the market and hindsight is 20/20 but there is a good example of one place, where one situation where it worked well. Another way that traders use the ADX is a signal of trend reversals when the ADX is trading above both the plus DI line and the minus DI line and then turns lower. This is often a signal that the current trend in the market is reversing and traders will position themselves accordingly. Ok, so you’ve got the trend here, you’ve got the ADX above 40, you see it turned down here and the market does reverse as a result of that. If you look back a little bit from that you'll see another break above 40 where the market did not turn and another break above 40 and then the ADX turned down and the market did not break below that. But, again there if you notice on the one we just looked at you did have a break of the trend line there so you have some additional confirmation that may have helped you not get faked out on that first one. If you had been following that strong trend line, we have looked at during last couple of lessons there

DI Line Crossover Strategy

The final example that we're going to look is what’s known as the DI line crossover. If you remember from earlier in the lesson the plus DI line is representative of the strength of the buyers in the market. The minus DI line which is red here is representative of the strength of the sellers in the market. And very simply in this strategy when the DI, when the plus DI line crosses above the negative DI line this is an indication that buyers are taking control of the market and some traders will look to go long. When that happens and when the plus DI line crosses below the minus DI line this is an indication that sellers are taking control in the market and some traders will look to go short. As a result of that, this is definitely one like the other crossover strategies that we've looked at that you’re definitely going to want to have some other confirmations on. But here is a situation where it would have worked out well to buy there on the crossover and sell there and there is a nice run up. And between those two points there is a lot of different ways to trade the ADX and there is a lot of other good information out there so I am going to try and put a together and put a link in the description section if you are watching this on You Tube or one of the other of video sites just below the video if you are watching it on informedtrades.com with some links to some other resources. The goal of informedtrades.com is to build a community of traders in a place were we can, we can all get together to learn the markets without all the hype that’s associated with most trading education. Every page on informedtrades.com has a comment section, so I encourage you to not only visit the site but to communicate with other members of the community by asking questions pointing out things you think others might find interesting and sharing your experience so we can all learn together. That’s our lesson for today. Tomorrow's lesson we’re going to learn about the parabolic SAR, which is an indicator that traders use to set stops when following trends in the market. So, we hope to see you in that lesson as always if you have any questions or comments please feel free to leave them in the comments section below or visit us at informedtrades.com and have a great day.

The speaker provides an overview of the ADX, or average directional index.  The ADX is an oscillator used to determine the strength of the prevailing trend.  He discusses some popular strategies used by traders to execute buy and sell signals using this technical indicator.

When the ADX is above 25, the security is trending or has started a new trend.  When this indicator fails at 40 or drops below 40, one can use this as an indication that a reversal is at hand.

Commodity Selection Index (CSI) Definition

The Commodity Selection Index (CSI) is a momentum indicator that uses the ADXR component of the Directional Movement indicator to select commodities suitable for short-term trading.  The CSI was developed by Welles Wilder and was first published in the book New Concepts in Technical Trading Systems.  The higher the CSI, the greater the volatility and strength of trend.  Traders use the CSI is to find commodities with the highest volatility, because it has the greatest odds of quick gains.  The CSI is designed for short-term traders that have money management rules that account for the risks associated with highly volatile markets.

Commodity Selection Index Charting Example