What is ADX Indicator - Formula, Strategy, Settings & Application in Day Trading

Do you know a famous Wall Street Investor, Hedge Fund Manager Mr. Bill Hwang, who lost over $20 Billion in just 2 days?

His firm Archegos (which means ‘one who leads the way’) failed to meet the margin call when the total value of the assets fell below the threshold level.

Investigators concluded he was involved in fraud by inflating the portfolio value from $1.5 billion to $30 billion.

There is an important lesson for all retail traders. They often try to trade against the market's major trend and lose money.

So, let's learn the market trend and how to identify the trend's strength using the ADX Indicator.

What is the Trend in Stock Market?

A trend is the general direction of a market or a stock's price.

Trends can be long-term, short-term, upward, downward, and even sideways. A trend can last for days, weeks, months, or even years.

When traders believe that an asset price will continue to rise, they are said to be bullish on that asset. They are said to be bearish if they believe the price will fall.

Image 1 - Uptrend and Downtrend

Trends can be caused by various factors, including economic news, changes in interest rates, supply & demand, and even political events.

When predicting future trends, it is important to consider all of these factors and how they might impact the market or asset price.

ADX provides a simple way to measure the strength of a trend at any point and in any time frame.

What is the ADX Indicator?

ADX is a technical indicator used in trading that measures the strength of a particular trend. The ADX indicator can be used to help traders determine whether a market is trending or not, as well as the strength of that trend.

Image 2 - ADX Line Above 20 Indicates the Strong Trend

The ADX indicator is considered to be relatively reliable when it comes to stock market trading, and has been used by many professional traders and hedge fund managers for years.

The main advantage of using the ADX indicator is that it can help traders to avoid getting caught up in false signals or noise that often occurs in markets.

By using the ADX indicator, traders can have a better chance of entering and exiting trades at the right times.

ADX Indicator Formula

ADX is calculated using +DM, -DM, and TR for a default of 14 days period.

You can check this to know all the formulas involved in the calculation of ADX.

ADX Indicator Settings

By default ADX indicator is calculated for 14-days period. One can reduce the time period to get faster signals. But faster signals may also give false indications.

ADX Indicator Strategy

ADX indicator consists of 3 components:

1. ADX Line

2. + DI and

3. - DI

When +DI is above -DI, it indicates bulls are stronger than bears.

When -DI is above +DI, it indicates bears are stronger than bulls.

When ADX Line is above 20-25, it indicates the trend is strong.

For long Trade:

Entry:

• +DI line is above -DI line and ADX Lines crosses 20. Entry should come above the high of the candle.

• ADX line is above 20 and +DI line crosses -DI line from downside. Entry should come above the high of the candle.

Stoploss:

• Below the low of entry candle or

• Fixed Stop-loss like 0.5% or 0.25% from the entry price

Target:

• Next swing high or

• Trial SL technique

Image 3 - Long Trade Entry Using ADX in Adani ENT

For Short Trade:

Entry:

• -DI line is above +DI line and ADX Lines crosses 20. Entry should come below the low of the candle.

• ADX line is above 20 and -DI line crosses +DI line from downside. Entry should come below the low of the candle.

Stoploss:

• Above the high of entry candle or

• Fixed Stop-loss like 0.5% or 0.25% from the entry price

Target:

• Next swing low or support zone

• Trial SL technique

Image 4 - Short Trade Entry Using ADX in Reliance

Caution - Always backtest this strategy against any trading instrument before using it.

You can also add 'Open Interest' concept along with ADX indicator to get the better results.

How to Apply ADX Indicator in Zerodha and Tradingview?

ADX indicator is available in both Zerodha and Tradingview. You can search for 'ADX' under indicators to plot this indicator.

Watch the video for the demo.

How to Use ADX Indicator in Intraday Trading?

PDH - stands for Previous Day High

PDL - stands for Previous Day Low

IB High - Initial Balance High (First 1-hour high after market open)

IB Low - Initial Balance Low (First 1-hour low after market open)

Long Trade:

Entry: When The price breaks PDH or IB High + ADX line is above 20 & +DI is above -DI

Stop-loss: Below the low of the entry candle

Exit: Target any next resistance zone or TSL

Image 5 - Intraday Long Trade Entry in Banknifty Using ADX Indicator

Short Trade:

Entry: When The price breaks PDL or IB Low + ADX line is above 20 & -DI is above +DI

Stop-loss: Above the high of the entry candle

Exit: Target any next support zone or TSL

Image 6 - Intraday Short Trade Entry in Banknifty Using ADX Indicator

You can also add 'Open Interest' concept along with ADX indicator to get the better results.

Options Trading Course

Options are a complex financial instrument and require careful consideration before entering into any options trade.

It is very important to understand OI interpretation with options before taking trades.

To learn more, you can register for this online options trading course