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Register for free at FX Academy, the first online interactive trading academy that offers courses on Technical Analysis, Trading Basics, Risk Management and more prepared exclusively by professional Forex traders. Report Broker Scams Forex Widgets. For example, if the market is choppy with lots of sideways action, entering a Forex trade based upon a trend following system such as moving average crossovers can result in the trade being quickly stopped out. The ADX indicator is useful for determining market conditions.
Developed by Wells Wilder, it uses the directional movement of price to determine its value. The calculation compares the trading range for one day to the trading range on the previous day.
If the low for the day is lower than that of the prior day, the result is negative directional movement. By then calculating the absolute difference between the two values and dividing by the sum of the two, Wilder determined whether the market was trending or not. Generally, if the ADX is above 20 the trader can use a trend following system. During the ranges, the trader can buy support and sell resistance until the ADX line moved above 20 again. Other clues about trend can be determined by examining the directional movement lines themselves.
The green line is for positive directional movement; the red line is for negative directional movement. This suggests the trend is moving upward, making the buy when ADX crossed over 20 a safer trade.
Note, too, that after this crossover, the positive, green line stays above the negative, red line for some time. In addition, the ADX line peaked well above both lines, at a higher level than it had previously achieved. The ADX line then turns downward and price enters a range-bound area within the upward trend.
The two directional movement lines move closer to each other during this generally choppy price movement as opposed to the larger difference between the two when the price was climbing upwards. In fact, although the trend has been, and remains, up in the Euro, there have been a series of ranges within this upward trend. Had the trader entered at point A, they likely would have been stopped out during this period. They then could have switched to range type trading.
This makes a long trade a safer entry. In summary, the rules for using the ADX indicator are: The trader can expect at least a sideways period but not necessarily trend reversal. It also may reverse. Often the two lines will meet and then part in the direction of the original trend as they do at point 2 on the indicator.
Other times, they cross over each other, indicating a possible trend reversal. Wilder suggested that when the lines meet, the trader could place a buy or sell order above or below the crossover point. In the case of the Euro, the low at the crossover point was 1.
The trader could place a sell order below that point. Deciding where that order should be can be tricky. However, assume you decided on 50 pips below 1. The price was touched and continued down to 1. You could have moved your stop to breakeven or slight profit before it reversed. If you had not done so, your loss would still be limited to that 50 pips. The ADX technical indicator is useful for gauging market conditions and for signaling peaks in trends where the market may then move sideways.
The trader should never use only one indicator to enter a trade. However, ADX can provide confirmation based upon other evidence to help a trader time his or her entries. As always, the trader should consider the risk and reward and use stops to limit losses. Sign Up Read Review. Free Forex Trading Courses Want to get in-depth lessons and instructional videos from Forex trading experts?
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