COMPONENTS

ADX Indicator: (setting = 12 to14)

10 SMA of ADX Indicator

5 SMA of price

ADX INDICATOR — AVERAGE DIRECTIONAL INDEX

Created by J. Welles Wilder, the ADX Indicator, also known as the Average Directional Movement Index, is non-directional and determines the strength of a trend. The Average Directional Index will rise in both uptrends and downtrends. The higher the ADX reading, the stronger the trend. Lower ADX readings indicate a lack of trend and price at that time may be in a range.

The default setting is usually 14, but other settings are used as well.

Although this oscillator fluctuates between 0 and 100, readings above 70 are rare. If the oscillator is below the 20 level, then price is without a doubt in a trading range and possibly in a tight consolidation. Readings above 25 indicate a trend. When the indicator rises above 50, it’s indicating a very strong trend.

Wilder also developed two other indicators called the Positive Directional Indicator (DI+) and the Negative Directional Indicator (DI-), which are combined and smoothed to create the ADX Indicator. If you want to get into the details of this indicator, check out Wilder’s popular 1978 book called New Concepts in Technical Trading Systems

ADX INDICATOR TRADING STRATEGY SIGNALS

Although, I have never used the ADX for my own trading, I have over the years heard of others using it with success. In fact, out of all the indicators I’ve learned about. and like I said, I’m not a big fan of indicators, this one seems to get the most positive comments. Some guys absolutely swear by it, but I’ve always just stuck with price and a bit of volume. This strategy is one that I heard about many years ago, that was supposedly being used by a stock day trader on a daily basis.

Most traders place too much emphasis on this indicator’s actual level. I think a much better way to use it, is to observe where its been and whether it’s rising or falling. After all, a reading might be 50, indicating a very strong trend, but if the ADX is falling, price could very well be at or near the end of the trend. So if you use the idea that a rising ADX is good, then trading a crossover of the ADX itself for the purpose of getting quick momentum type scalps might be a reasonable approach.

Buy Setup: 5 SMA is rising and ADX is between 20 and 45

Buy Trigger: ADX crosses above its average

Exit: Discretionary

Short Setup: 5 SMA is falling and ADX is between 20 and 45

Short Trigger: ADX crosses above its average

Exit: Discretionary

The filter requiring the ADX indicator to be between 20 and 45 helps to weeds out trades, that could either stay range bound or be overextended and at the tail end of a trend.

EXAMPLE

Alternate ADX Indicator Method

An example using a 5 minute chart of SPY is below.