Rohit Musale, CFA
The 5 Benefits of Using the ADX in Trading
I have always said that you should not be using more than three indicators on your charts.
Three should be more than enough.
At the max, if you want to use the fourth one, go with a simple moving average.
It is one of the most powerful indicators or trend following indicators in technical analysis.
And out of those three indicators that I mentioned, one of them has to be Bollinger Bands, because it is too important to ignore.
Out of the remaining two, I would recommend using the ADX.
Here are five benefits of using ADX or Directional Movement Indicator, in your trading:
1) It helps filter the markets to trade.
Let's say that, you are using Bollinger Bands and RSI, to identify trades in the market.
Once you identify the trade, how do you know whether that market is really a market that you should be trading?
What if the trend is weak?
ADX helps us in solving this problem.
ADX can tell you which markets to trade and which markets not to trade at any given point in time.
2) It shows who is the dominant market group currently in the market.
So, for example, if the bulls are stronger, the ADX will indicate that.
If the bears are stronger, the ADX has the potential to indicate that as well.
So, when bulls are stronger, you avoid taking a short trade and when the bears are stronger, you would avoid taking the long trade.
That way the ADX comes as a filtering system.
3) It shows the power shift in the market.
The ADX has got three lines, one is the ADX line, one is the bull line and the third one is the bear line.
When the bull line crosses the bear line, you could say that the power is shifting from the bears to the bulls and vice versa.
So the ADX can tell you, or the directional movement lines can tell you, when the power shift has happened in the market.
4) It shows the strength of a trend.
Well, it is very common knowledge that, anything above 20 on the ADX reading means that, you are allowed to use a trend following system, and anything below 20 on the ADX, then you are not allowed to use a trend following system.
In that way, it shows the strength of the trend.
The higher the ADX reading, the stronger is the trend, irrespective of whether it's an uptrend or a downtrend.
5) It gives an early signal to exit.
The ADX not only shows the strength of the trend, but it is also a soft signal, in a sense that, it can tell you when exactly to fully close a position.
The ADX has the potential to spot weakness and gives you the indication, so it can give you the optimum point to exit from the market.
I have covered the ADX in detail in Level 12 of my Japanese Candlesticks Trading Mastery Program.
Have a look at that course.
I have covered every possible application of the ADX in combination with Bollinger Bands and RSI.
Preview some of the videos there.
Thank you so much.
Rohit Musale, CFA
14 February 2023