ADX: The Trend Strength Indicator

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ADX: The Trend Strength Indicator
ADX ValueTrend Strength
0-25Absent or Weak Trend
25-50Strong Trend
50-75Very Strong Trend
75-100Extremely Strong Trend

Low ADX is often indicative of accumulation or distribution. Price enters range circumstances when ADX falls below 25 for more than 30 bars, and price patterns are frequently simpler to discern. Price then goes up and down between resistance and support, indicating selling and buying activity. Price will ultimately break out into a trend from low ADX circumstances. The price goes from a low ADX price channel to an uptrend with a high ADX in the chart below.

When ADX is below 25, price enters a range. When ADX rises above 25, price tends to trend.

Image by Sabrina Jiang © Investopedia2020

The direction of the ADX line is important for reading trend strength. When the ADX line is rising, trend strength is increasing, and the price moves in the direction of the trend. When the line is falling, trend strength is decreasing, and the price enters a period of retracement or consolidation.

Periods of low ADX lead to price patterns. This chart shows a cup and handle formation that starts an uptrend when ADX rises above 25.

Image by Sabrina Jiang © Investopedia2020

A common misperception is that a falling ADX line means the trend is reversing. A falling ADX line only means that the trend strength is weakening, but it usually does not mean the trend is reversing, unless there has been a price climax. As long as ADX is above 25, it is best to think of a falling ADX line as simply less strong (shown below) (shown below).

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When ADX is below 25, the trend is weak. When ADX is above 25 and rising, the trend is strong. When ADX is above 25 and falling, the trend is less strong. Image by Sabrina Jiang © Investopedia2020

Trend Momentum

The series of ADX peaks are also a visual representation of overall trend momentum. ADX clearly indicates when the trend is gaining or losing momentum. Momentum is the velocity of price. A series of higher ADX peaks means trend momentum is increasing. A series of lower ADX peaks means trend momentum is decreasing. Any ADX peak above 25 is considered strong, even if it is a lower peak. In an uptrend, price can still rise on decreasing ADX momentum because overhead supply is eaten up as the trend progresses (shown below) (shown below).

ADX peaks are above 25 but getting smaller. The trend is losing momentum but the uptrend remains intact.

Image by Sabrina Jiang © Investopedia2020

Knowing when trendmomentum is increasing gives the trader confidence to let profits run instead of exiting before the trend has ended. However, a series of lower ADX peaks is a warning to watch price and manage risk. The best trading decisions are made on objective signals, not emotion.

Momentum divergence may also be seen using ADX. Negative divergence, or non-confirmation, occurs when price hits a higher high and ADX makes a lower high. Divergence, in general, is not an indication of a trend reversal, but rather a warning that trend momentum is shifting. It may be necessary to increase the stop-loss or accept partial winnings.

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When a trend’s character changes, it’s necessary to analyze and/or manage risk. Divergence may cause a trend to continue, consolidate, correct, or reverse (below).

Price makes a higher high while ADX makes a lower high. In this case, the negative divergence led to a trend reversal.

Image by Sabrina Jiang © Investopedia2020

Strategic Use of ADX

The single most essential indication on a chart is price. Read the price first, then the ADX in the context of what the price is doing. When any indication is utilized, it should contribute information that price alone cannot provide. The finest trends, for example, emerge from times of price range consolidation. Breakouts from a range occur when there is a price dispute between buyers and sellers, tipping the supply and demand balance. Price momentum is created when there is more supply than demand, or when there is more demand than supply.

Breakouts are easy to notice, yet they often fail to advance or become a trap. ADX, on the other hand, shows you whether a breakout is real by indicating when ADX is strong enough for price to trend following the breakout. Price is strong enough to continue in the direction of the breakthrough when ADX climbs from below 25 to above 25.

ADX as a Range Finder

When price shifts from trend to range circumstances, it is frequently difficult to notice. The ADX indicator indicates when the trend has weakened and is approaching a phase of range consolidation. When ADX falls from above 25 to below 25, range circumstances prevail. The tendency in a range is sideways, and there is broad price agreement between buyers and sellers. The ADX will wander sideways below 25 until the supply-demand balance shifts again.

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When paired with price, ADX provides excellent strategy indications. First, utilize ADX to evaluate if prices are trending or not, and then choose the best trading strategy for the situation. In trending situations, entry are made on pullbacks and are taken in the trend’s direction. Trend-trading tactics are ineffective under range settings. However, trades on reversals at support (long) and resistance (short) levels may be made (short).

The Bottom Line: Finding Friendly Trends

Profits are made by trading the strongest trends and avoiding range circumstances. ADX not only detects trending situations, but it also assists traders in identifying the strongest trends to trade. The ability to assess trend strength gives traders a significant advantage. ADX also recognizes range situations, preventing traders from getting caught attempting to trend trade in sideways price movement. Furthermore, it indicates when price has broken out of a range with enough power to apply trend-trading tactics. ADX also informs traders to changes in trend momentum, allowing them to handle risk management. If you want to be friends with the trend, don’t allow ADX become a stranger.

Those who wish to learn more about ADX and other financial issues might consider enrolling in one of the finest technical analysis courses available right now.

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