By David Adams
One of the most important concepts in e-mini trading is to learn to trade with the trend. Of course, trends come in varying intensities and magnitudes. The question many e-mini traders face is whether they are entering a trade in a strong trend or a weak trend. Strong trends typically produce sizable profits and weak trends can often end with a loss. It’s in every trader’s best interest to discern the strength and intensity of a trend in which they may choose to initiate a trade.
The Average Directional Indicator and its sister indicators, the Minus Directional Indicator (-DI), and the Plus Directional Indicator (+DI) are part of a group of indicators developed by Welles Wilder in his 1978 book, “New Concepts and Technical Trading Systems.” As an aside, I highly recommend reading this book as it is one of the landmark texts in technical trading. Along with the above-mentioned indicators this book also laid the groundwork and explained the Relative Strength Indicator (RSI), Average True Range (ATR), and the RSI. These indicators have been around since 1978 and are still the basis for a great deal of technical analysis.
The ADX is used to determine the strength of a trend. I do not use it as a primary indicator in my personal trading, but rely heavily upon it as a secondary indicator to indicate whether the trend in which I am participating is a powerful or weak trend. Generally speaking, the default setting for the ADX is set at 14 bars, though I have seen traders adjust the setting as high as 50 bars and as low as 8 bars. The ADX is generally plotted on the same plane as the +DI and -DI. When the +DI and -DI cross it is generally considered a potential entry point for a trade. The ADX, however, will give the trader a good idea whether or not this potential entry point is part of a strong trend or merely a spurious trade signal in a range bound market. The ADX is plotted on a continuous graph from 0 to 100. For the most part, the strength of the trend, as measured by the ADX is as follows:
• 0 – 25 indicates a lack of trending market action.
• 25 – 50 indicates a strong trending market.
• 50 – 75 indicates a robust trend.
• 75 – 100 indicates an extremely powerful trend.
Like many technical indicators, it is important to understand that the ADX is a lagging indicator. This does not necessarily have to be an impediment to using the ADX though, because e-mini traders often enter trades too early in a trend and are subject to false breakouts and false breakdowns. So the ADX can assist an e-mini trader in entering a trend at the proper time.
It is also important to understand that the ADX is non-directional, which is to say that it does not indicate the direction of a trend, only the strength of a trend. For example, a strong downtrend may register 58, and a strong uptrend can also register 58. The point is a simple one; the ADX only measures the strength of a trend and not the direction of a trend. So, when the ADX is rising the strength of a trend is increasing either long or short. By the same token, when the ADX is falling the strength of a trend is waning.
In summary, this has been a short introduction into the use of the ADX and more study and actual experience is required to use it effectively. We have noted that the ADX measures trend strength and is a non-directional indicator. It does not measure the direction of a trend, only the strength of the trend. Finally, we have given some general guidelines on ADX readings that quantify the strength of the ADX indicator. Learn more about this indicator, as it is useful and can be a valuable addition to your trading.
About the Author
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