The Average Directional Movement Index, or ADX, is a technical indicator developed by J. Wells Wilder in the 1970s to measure trend strength. Applied to the foreign exchange market, or Forex, the ADX can help identify whether a currency pair is trending or trading sideways. The ADX is an oscillating indicator that can also signal when a trend is running out of steam. The ADX works best in a trending market.
Understand that the ADX consists of three lines: the ADX line itself, a + directional indicator (DI) line and a – DI line. On charts, the ADX line is usually white or black. The +DI line is green and the –DI line is red. The ADX ranges from zero to 100. Horizontal lines are usually drawn at the 20, 40 and 60 levels. An ADX reading between zero and 20 indicates a weak or unclear trend. Between 20 to 25, a trend may be developing. From 25 to 40, the currency pair is in a strong uptrend or downtrend. At 60 or higher, the currency pair is overbought or oversold.
Apply ADX trade entry rules to your currency pair. Stay out of the market when the ADX ranges between zero and 20. When the ADX fluctuates between 20 to 25, add another indicator such as the Moving Average Convergence-Divergence (MACD) to confirm the trend. The +DI line crossing over the –DI line (green line above the red line) indicates strong buying. The –DI line crossing over the +DI line (red line above the green line) indicates strong selling. When the ADX remains above 25 but below 40, look for a good entry point. The ADX moving above 60 indicates the currency pair is overbought or oversold. Consider closing out your trade.
Using an example, you decide to trade the EUR/JPY (euro/Japanese yen) currency pair. The ADX is below 20, indicating the currency pair has no identifiable trend. When the ADX moves above 25, you confirm the trend’s strength with another technical indicator, such as the MACD. You wait for the +DI line to cross over the -DI line before entering your trade. The EUR/JPY price rises and the ADX reaches 40. When the ADX hits 60, the +DI line starts to weaken. Confirm the faltering trend with your other technical indicators and close out your trade.
Understand the ADX weaknesses. The ADX gives you false readings if you use it when your currency pair is trading sideways. The ADX does not indicate a bullish or bearish trend but only the strength of the trend, which can be confusing. The ADX gives you an idea of where the currency pair is in relation to the trend. It does not give you definite trade entry and exit points.
- The ADX is usually found beneath the currency pair’s price chart.
- Currency trading can be very risky. Only trade with money you can afford to lose.
Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.