ADX: The Trend Strength Indicator
When the DI lines cross each other, they give a signal; when the green line crosses above the red line, it means that the highs and lows of the previous candles are both moving higher which confirms an uptrend. In an uptrend, price can still rise on decreasing ADX momentum because overhead supply is eaten up as the trend progresses Figure 5. For more info on how we might use your data, see our privacy notice and access policy and privacy website. The trend is losing momentum but the uptrend remains intact. Remember the default is
Our Trading Courses & Mentorship
Where do we start, well first those perfect trade examples were just cherry picked trades from chart history when the chart conditions were perfect to allow them DMI strategies to work at their best.
Surprisingly, the random chart situation we picked for the crossover strategy actually provided better trade signals than the 25 cross strategy we showed prior to this. Some of the trades did move into some profit. That means the trader would have eventually been stopped out on every trade or at least broke even on the ones that did start to work out.
Either way this strategy would have resulted in a net loss. We know that the DMI was designed to determine trend strength by passing candlestick high, low and close data through a series of mathematical calculations and logic statements. Trends are easily and quickly identified by successions of higher highs and higher lows uptrends , or, a succession of lower highs and lower lows downtrends.
We wait for weakness in a bullish trend and buy in via a price action signal at the trend swing levels, or we wait for signs of strength in bearish markets and sell price action signals that form at swing levels. In the chart shown above we can quickly identify the uptrend by observing the higher high and higher low pattern. By waiting for weakness in this uptrend and using a price action signal to trigger us into the trade we are able to take advantage of excellent market prices for trade entry.
This is much more effective than using the DMI outputs, as the Directional Movement Index signals will typically signal you to buy in at high prices and sell the market at lower prices. By making the switch to price action trading we can easily arrange a funeral for this oscillating crossover nightmare known as the Directional Movement Index. Once you throw away your indicators and clean up your chart from any mess you will really start to look at the charts in a whole new light.
Clean price charts really start to bring out clarity in the markets, and by using price action trading techniques your confidence in the markets is going to dramatically improve. So what does the Directional Movement Index do?
You will see two lines inside the new indicator window, usually colored green and red. Run the data through some logic. How DMI is typically used in the markets. The -DI line is a quantified value of bearish strength. The second part of the ADX indicator are the two DI lines which are usually color-coded red and green in our example. The DI lines provide directional information and they also measure trend strength.
The only thing you should remember is that the DI lines compare the absolute candle highs and the absolute lows of candles. Here are a few scenarios:. On the screenshot below, we set the DI period setting to 1 which means that the indicator just compares the two most recent candles. This is a good way of understanding the DI calculations quickly. Keep in mind, the DI just looks at the absolute high and the low not the candle body.
When the DI lines cross each other, they give a signal; when the green line crosses above the red line, it means that the highs and lows of the previous candles are both moving higher which confirms an uptrend. When the red DI line crosses above the green DI line, it shows that over the past candles, price has been moving down and the lows and highs are going lower.
In the screenshot below we can see this nicely. First, the ADX line crosses above 20 first black vertical line but at this point, price was in a range. Then, things turned around and the green line broke above the red DI line and the ADX started to pick up again.
Once the red DI line crossed above the green line, the trend was over red vertical line. You can see that the first signal came a bit late and the ADX crossed 20 once price had been rallying already and at that point, the DI lines were very wide apart already; ADX signals are usually stronger when the DI crossover and the ADX line-break happen at the same time or relatively close.
As with every system, you have to learn how to maximize winners and cut losses and small profits effectively. In such a scenario, a trader must be fast with cutting his loss.
Staying in the trade would have been the real challenge here as the ADX showed the hook and then kept on trading lower. The ADX hooked once price stopped its fall and entered the consolidation.