Watching the stock market involves a lot more than just glancing at the ticker prices as they scroll by on the evening news.
Indicators exist to help investors make decisions based on inference, trends, and extrapolation. Without them, we’d still manually crunch numbers and cross our fingers that our calculations are correct.
The ADX indicator is popular because of its ability to show both the past and future of a particular stock’s volatility, which in turn provides vital insights into the best times to trade.
Overview of the ADX Indicator
Before you can jump into using the ADX indicator as the ultimate weapon in your day trading arsenal, you need to understand what it is, what it measures, and what the math means.
What is the ADX Indicator?
ADX, or the Average Directional Index, is an indicator that determines strong price trends for a stock over a set time frame.
When you look at an ADX chart, you’ll see three components:
- DI+ is the plus directional indicator, represented as a green line. It is a measure of the strength of positive price movement.
- DI- is the minus directional indicator, represented by a red line. It is a measure of the strength of adverse price movement.
- The ADX line is black or yellow and shows the average strength of the peaks and valleys.
What does the ADX Indicator Measure?
Up, down, left, right… What does it all mean?!
First and foremost, day traders using the ADX indicator need to know that it is a non-directional trend, so they don’t use it to determine the trajectory of a stock’s cash value.
A “downward” turn does not mean that the price is falling. It just means that the strength of the trend is decreasing.
You’ll usually see the ADX reading get lower when the stock is in a sideways drift, and the range between daily highs or lows isn’t as extensive.
It will also fall when the fluctuations are so choppy that there isn’t a clear trend.
Calculating Trend Strength
We won’t make you read through an extended example calculation, mainly because plenty of tools calculates ADX for you. It’s good to understand the equation behind the ADX indicator for day trading:
+DM= today’s high – yesterday’s high
-DM= today’s low – yesterday’s low
ATR= average true range
The Trend Strength Scale
Once you’ve calculated that equation, you end up with a trend strength number.
The ADX measures trend strength on a scale of 1-100. A higher number means that the trend is more substantial, while a lower number means the trend is weaker:
- 0-20: Very weak trend
- 20-30: Developing trend
- 30-40: Strong Trend
- 40-60: Very Strong Trend
- 60-100: Extremely Strong Trend
Generally, traders use these numbers as buying and selling signals when certain events happen between the -DI and +DI lines.
If the +DI line crosses over the -DI line, AND the ADX is greater than 25, it’s an indicator to buy because there is a growing trend of downward price fluctuations.
If the -DI line crosses over the +DI line, AND the ADX is greater than 25, it’s an indicator to sell or short trade because there is a growing trend of upward price fluctuations.
Don’t solely base your ADX indicator for day trading scale on general trading, though.
Instead, use it as a tool to inform your investment strategy, then work within the ADX indicator scale range that makes the most sense.
How to Use ADX Indicator for Day Trading
Most of what we’ve talked about so far are the ADX indicator’s general uses as a trend tool. Day traders will still find it helpful, but some adjustments are necessary.
Adjust Your Term
If you’re wondering how to use the ADX indicator for day trading, it starts by adjusting your term.
Day trading is fast-paced, so focusing on 14 periods, the ADX indicator norm, won’t work. You’ll want to focus on a shorter range of three intraday periods.
Shift Your Buy/Sell Signals
You’ll also want to ignore the “greater than 25” rule and instead wait for the ADX to go above 50. This indicates a powerful trend and helps day traders make highly informed, short-term decisions about buying and selling.
It also aligns with the tried-and-true rule that day traders stop trading when the market stalls. A weak trend is a sign of consolidation, so it’s best to step back until things start moving again.
Watch for Entry Points
The ADX indicator can be a day trader’s best friend if they recognize trend strength readings and react accordingly.
As we said earlier, there are times when the +DI and -DI cross over one another, indicating that a trend is reversing.
When the +DI crosses over the -DI line, consider buying. It means that the stock is low but increasing. Snag shares before the uptick continue for too long.
Vice versa, sell when the -DI crosses the +DI line. That means a downward trend is occurring, and you probably want to pull out before shares drop lower.
Don’t Lean on the ADX Alone
The best strategy for using the ADX indicator for day trading is to combine it with other tools. Intraday indicators give you more data to base your decisions on and help make your ADX number more meaningful.
It would be best to recognize that indicators alone will not make you a successful day trader. Making the market work for your trading style requires a more complex system of knowledge, interpretation, and experience.
With my trading programs, I’ll show you why indicators are only one of the tools you’ll need to become an experienced trader.
We’ll explore complex strategies that encompass everything from the technical aspects of market analysis to developing your personal algorithm.
Most importantly, you’ll gain an extensive, practical knowledge of the stock market while cultivating confidence in your brand as a trader.