Catching moves with the ADX

The average directional movement index, commonly abbreviated ADX, is a complicated indicator in three parts:
•    The ADX line proper, which measures the presence and strength of a currency pair’s trend.
•    The positive directional movement index (+DMI), which measures buying or bullish strength within that trend.
•    The negative DMI (−DMI), which measures selling or bearish strength within the trend.

The ADX line illustrates the trend strength over a chosen lookback period, with 14 time periods being the most common:
•    Readings above 30 indicate the presence of a trend, with higher figures indicating greater strength.
•    Readings below 20 indicate the absence of a trend.
•    Readings between 20 and 30 indicate market indecision:
o    a rising line in this bracket means a trend may be beginning, and
o    a falling line in this bracket means a trend may be ending.

Note that the ADX line does not speak on the direction of the trend, merely its presence and strength. A falling ADX line may mean an uptrend is coming to a close, while a rising ADX line may accompany falling prices.

These three lines are graphed as oscillators in an indicator window beneath the chart, the two DMIs generally as dashed lines of two different colours such as green and red. The result is a distinctly unique indicator that can be used to call trends and microtrends in a choppy market.

Below is the fifteen-minute chart of the Australian dollar versus the Japanese yen, currency pair AUD/JPY:

The vertical brown lines mark points where the −DMI cleanly crosses above the +DMI, indicating selling pressure outweighs buying pressure. The vertical green lines mark the opposite—points where +DMI crosses cleanly above the −DMI, indicating buying pressure heavier than selling pressure. Time periods where the DMI lines entangle are ignored.

The overall trend is bullish turning bearish for AUD/JPY during the chart’s time period, as illustrated by the grey arch of the 200-period moving average across the top of the chart. Moving averages of ten periods (purple line) and five periods (light blue line) are also included, to serve as points of comparison with the ADX signals.

Note that roughly half the time, the DMI crossover occurs several candles before the moving average crossover, making this a more sensitive indicator.

Note also that when the DMI crossover occurs while the ADX line is falling, there is little price movement worth trading, or the price movement present is too choppy for this chart’s periodicity. The good, profitable trading moves occur following a DMI crossover while the ADX line is rising. Some false entries, then, can be avoided by utilising the 30 ADX level as an entry trigger:
•    If the DMI lines cross but the ADX level does not reach 30, there’s no trade.
•    If the DMI lines cross and the ADX line crosses above 30 shortly thereafter, the trade’s on.