How often does it happen that you entered a trend and thought that this could be your chance but then find out that the trend has spent its time already and got too late? A lot of trading strategies can help us forecast market trends and let us predict that if it will be bearish or bullish, but giving less or no clue about the strength of the trend. Sometimes these Forex Trading strategy lead us to enter a trade but turn out to be very less and not enough worth profit, even though all things have gone the way we expected.
ADX ( Average Directional Index ) is a tool that is created to predict the strength of the trends and help us avoid such situations. Combining other Forex trading strategy with ADX can allow us to understand and predict the trend altogether, and thus let us enter big profit yielding trades. ADX is not a complete standalone Trading strategy as it can only predict the strength of the trend. It doesn’t give any other indications like trend direction, etc., So it should be used in combination with different strategies.
Understanding the Average Directional Index is very easy. It ranges on a scale from 0-100, 100 indicating a very strong trend and 0 indicating a non-existent trend. If the ADX is very close to 0, expect a sideways moving trend, meaning the market will not go up or down but rather stay around the same value with small corrections. When the ADX is low it is a good time to consider closing the trade as you don’t stand to make a profit from a sideways moving market. On the other hand, if the ADX is very high, expect a fast moving trend which means that it is probably a good time to enter a trade. Don’t forget, the ADX is only an indication of the strength of the trend and does not indicate whether the price will go up or down.
Values of ADX that are considered high are above 50. Whenever there is a strong trend, the ADX will be above 50. Weak trends are indicated by values under 20 on the ADX scale.
This example clearly shows how we can use the Average Directional Index to analyze the trend:
As you can see, in the first part of the chart there is a very strong bearish trend and the ADX (shown on the bottom) is very high. Once the trend ends, and the market begins a sideways stage, the ADX drops below 20. In this case, using the ADX could have helped us exit the trade when it had reached the end of the trend and not waste our time and resources on currency pairs that are not going anywhere.
Combining the ADX indicator with your other Forex trading strategy can give you just the edge you need to increase your profits.