A Trading Plan Using ADX
Here is a quick and easy AXD trading setup that can be used as a complete trading system or alongside other tools such as Candlestick Patterns.
On 15 May, 2014, the Candlestick Trading Forum had Greg Weitzman as its guest presentator.
In the video, Greg outlined a trading strategy that used a Trend Strength Indicator, the Average Directional Index (ADX) – also known as the DM Indicator – to signal trend changes, entries and exits as well as for trade management. According to Greg, the strategy works in any market and on any stocks/ETFs/options/futures/day-trading/swing-trading/Forex in any timeframe.
The ADX has three components:
ADX – Based on a moving average of price range expansion over a given period of time. The default setting is 14 bars. ADX is plotted as a single line with values ranging from a low of zero to a high of 100. It registers trend strength whether price is trending up or down;
Di+ The positive directional movement indicator, measuring how strongly price moves upward (Bulls or Buyers);
Di- The negative directional movement indicator measuring how strongly price moves downward (Bears or Sellers).
These indicators are available of most charting platforms and, although many will combine all three on on panel, some allow you to easily modify them to make them somewhat clearer.
Here is an example of how a chart can be set up on http://www.freestockcharts.com with the ADX shown in a separate panel (and in the form of a histogram) above a panel showing the Di+ and Di-.
The Four Steps of how to use this
Step 1. Look for the strength of the trend on the ADX. If there is no trend, we can’t plan a correct trade.
0-10: If the ADX is below 10, the market is trendless and there is nothing to be done
10-20: The market is looking to a new trend. There are no trades to take yet, but it is time to set some alerts.
20-40: The market is in a trend
40+: The market has become exhausted
Step 2. Determine who is dominating the market, the Buyers or the Sellers.
Whichever one of the Di+ (Bulls or Buyers) or Di- (Bears or Sellers) is on top shows who is in control.
Sellers are in charge when the red line is on top and the Buyers are in charge when the green line is on top.
Step 3. Combining the ADX with the Di+ and Di-
If we cross 20 in the ADX, we start looking for an entry at the next cross of the Di+ and Di-. This provides a confirmation with a signal that is easily recognizable and repeatable and it also helps avoids areas where the stock might be overbought or oversold.
You can also complement this with a knowledge of candlestick patterns.
If the ADX falls below 20, it’s a sign of weakness, but you don’t necessarily want to get out of the trade or wait for the Di to cross and enter a counter-trend trade.
Exit a trade when the market becomes exhausted (ADX >40) or if the market becomes trendless (ADX < 10)
The ADX System is generally good however, in choppy markets, it can give false entries. The solution to this is to use non-time based charts (Renko, Range, and Tick charts).