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Average Directional Movement Index – The Money Maker?

Best Binary Options Free Trading Tools  – Average Directional Movement Index

Yesterday evening, after I finished my trading day, I turned away from my computer trying to review my own trading decisions and the tools I use. There really are no certainties when it comes to any form of trading, be it Forex or Binary. The best we can do is increase the probability of our next trade, using market analysis and of course, tools like indicators, price action and Support and Resistance levels. In my early days of trading I always heard the “old” guys telling me to “go with the trend”. Ok, but that is sometimes easier said than done if you are a rookie and let me tell you, from time to time everybody has difficulties when it comes to trend recognition. Then I remembered: I know a free tool that shows the strength of a trend. Enter the Average Directional Movement Index, also known as ADX. It may sound complicated, but I can assure you it is not, although there are some tricks to be learned. First one is that ADX never shows the direction of price, but the strength of the move, so price could be moving down and ADX up. That just shows that the down move is possibly turning into a downtrend. ADX has levels that once crossed, price is considered trending and trend following strategies are more likely to be successful. The levels are somewhat controversial because some traders strongly advise that ADX should be over the 30 level before we can consider we are in a trend and others say a trend is developed once the 20 level is crossed. I don’t like to argue so I just use the 25 level. When ADX reaches extreme readings (50-60), we must be very careful because the trend might be in need of a retracement or consolidation. Under 25, I consider that no trend is present and I apply range strategies. Let’s see what are the pros and cons of this tool.

 

 

Why ADX sucks?

Well, the first time I installed it on my computer I wanted to immediately take it off. It just looks like a mess sometimes…but after a while I got used to it and I realized that is actually an advantage because it shows me that price has no clear direction. Look at the picture below, in the lower left box and see how all the lines are tangled and hard to read. It’s a clear indication that price has no trend at the moment. ADX uses a mathematical formula to smooth out price movement and plot its lines, but in doing so, it lags a bit and sudden moves in price can be reflected late by the ADX. Well…nobody’s perfect.

 

 

Why ADX doesn’t suck?

If you are not used to analyzing the Highs and the Lows to correctly determine whether you are in a trend or not, the ADX is a simple and visual representation of price strength. Just use the levels to determine if price is trending or not or if a possible reversal might come. However, one of the biggest advantages in my opinion comes from the fact that it keeps me disciplined. For example, it stops me from opening a trend continuation trade if ADX is under 25. As soon as the condition is met, I can trade, but never before. This keeps me out of false moves and whipsaws and we know we have a lot of those lately. Ok, let’s see the ADX in action:

 

 

How to use ADX

There are two additional lines (red and green) to the main one (blue). When the red dotted line is above the green dotted line, means that the bears are holding the power (but it’s a frail situation). To put it simple, under the 25 level, nobody is clearly dominating the market but if the red line is above the green, the bias is slightly bearish. But you can see once the ADX starts to rise and the red dotted line is above the green dotted line, the bears are clearly in control. Usually, once I see this type of situation developing, I wait for a retracement against the main trend and after that I place a Put, going in the direction of the trend. Although it can be a bit confusing at first, ADX is a great tool that keeps us on the right side of a trend and for this reason, it has found a permanent place on my charts.

 

 

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