Are you looking for a technical indicator that will evaluate the strength of a trend? IF that is the case, we can name one of the most popular and used ones that do this job: the Average Directional Index. This technical indicator helps a trader gauge the trend strength without worrying about its direction.
The average directional index
The average directional index is also known as ADX. This technical indicator is also an oscillator. It has a scale that ranges from 0 to 100. If the reading shows that the value is below 20, then the trend is weak. If the reading indicates that the value is higher than 50, it signals a strong trend.
The higher the ADX, the stronger the trend, and the lower the ADX, the weaker the trend. It does not matter if it’s a downtrend or an uptrend. When the ADX is low, the prices are usually going sideways, or the trading is ranging. When the ADX is high, and above 50, the price’s momentum is going in one direction.
If we think about it, it is somehow similar to a stochastic oscillator since it has a 0 to 100 scale, and it evaluates the trend’s strength. However, ADX cannot determine whether the trend is bearish or bullish. It can only do so much and measure the current trend’s strength. This is why traders only use the ADX when they want to know whether there is a new trend or the market is ranging. We can consider ADX as a non-directional technical indicator since it is based on the highs and lows comparison, and it also does not use the bar’s close.
Average directional index and how it works
If you decide to use the ADX, always monitor 20 and 40 since they are key levels. Let us give a little summary that you can use as a cheat sheet:
- Rising ADX value = trend is getting stronger
- Falling ADX value = trend is getting weaker
- Below 20 ADX value = trend is weak
- In between 20 and 40 ADX value = trend is strong
- Above 40 ADX level = trend is extremely strong
Trading with ADX
Traders have many styles, and they can use the ADX in many ways. One of these ways is waiting for breakouts before deciding if you will go long or short. Why is that? One of ADX’s abilities is confirming whether the currency pair can continue in its current trend or not. Another way is using ADX with another indicator. It would be better if this indicator mainly helps you know whether the currency pair is about to go downwards or upwards.
ADX can also help traders know if they should close a trade. For example, when the ADX starts to go lower than 50, the currency pair tends to go sideways. In this case, the ADX gave the trader some clues to close earlier.
A summary to end the topic
The ADX is one of the popular technical indicators that help traders know the trend’s strength. It is almost the same as the stochastic oscillator. However, it cannot tell whether it is bullish or bearish. We can use ADX for trend confirmation, knowing if the trend will go up or down, and knowing if you should close the trade early.