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ADX Trading Strategy – Profit with a Single Indicator

ADX Trading Strategy

Recently I read a book ADXcellence: Power Trend Strategies that focusses only on a single indicator. This is one of the best books of ADX trading strategy. Let me discuss the strategies explained in this book.

Who wrote the book on ADX trading strategy?

Dr. Charles B. Schaap wrote this book. When he stopped being a doctor, he started trading stocks, futures, and options full time. ADXcellence Power Trend Strategies (2006) Articles in Technical Analysis of Stocks and Commodities, SFO, Working-Money Money, Medical Economics, and other newsletters. He was a speaker for the International Traders Expo and other investment groups. Also he was the Hedge Fund Association in charge.

Items and Indicators he Traded

ADX and the Dow in the Long-Term

First we will explain the ADX indicator and show how to trade with ADXodus, ADXtender Momentum Divergence, and Reversals with one single indicator. In the conclusion, I will also show you five major benefits of using ADX to trade your market.

Frequently Asked Questions about ADX

What’s the ADX?

ADX is an indicator that shows the direction and strength of a trend. ADX shows if the bulls or the bears are in charge.

Why you should use ADX?

No system to buy, just a free indicator measures how strong a trend is. Lets us see at the same time how strong bulls and bears are. Tells us when the trend is strong enough to trade. Tells us when the trend is weak (stand aside). Works for all products and time frames. Can be put together with other signs.

What is ADX and DMI?

J. Welles Wilder came up with the Average Directional Movement Index (ADX) and wrote about it in his book, New Concepts in Technical Trading Systems (1978). ADX is made up of the Positive Directional Movement Indicator (+DMI) and the Negative Directional Movement Indicator (-DMI), which were both made by Wilder.

  • The goal of trading is to make money.
  • Myth: If you want to make money on the stock market, you have to know what’s going to happen.
  • Truth: Before the market moves, you need to know what you’re going to do.

ADX Trading Strategy from the Book

The information for this post comes from ADXcellence Power Trend Strategies.

Indicator Settings

DMI 13, ADX 8

You can easily set this up in Zerodha Kite. Check the image below to know how to change the default ADX settings. We are using the TradingView chart in Zerodha Kite here.

ADX in Zerodha Kite

Change in Direction (DM)

DM is the biggest difference between today’s range and yesterday’s range. When most of today’s range is higher than yesterday’s range, we have a positive DM (+DM). Similarly, when the majority of today’s range is lower than yesterday’s range, the DM is negative (-DM).

When the DMI lines split and ADX goes up, the trend is getting stronger. When the DMI lines meet, ADX goes down and the trend gets weaker.

ADX is mostly used to measure how strong a trend is. DMI CONFIRMS the direction of a trend and CONFIRMS price signals for when to buy or sell. When ADX > 25 If +DMI is higher than DMI, prices tend to go up. If DMI is higher than +DMI, prices are falling.

ADX is Nondirectional

ADX measures how strong a trend is, but it doesn’t care whether the trend is going up or down. It goes up when there is a strong uptrend. ADX goes up when there is a strong downtrend. Price range shrinks and grows on a regular basis.

The ADX number of 25 is the magic number that says a trend is strong. When ADX drops below 25, price is usually in a period of consolidation, and trading strategies based on trends will usually fail. When ADX goes above 25, a trader can use strategies for trading with the trend.

The best trades start during low ADX. When ADX stays below 25 for a long time, draw price trendlines and wait for a breakout.

Breakout Trading Strategy

A valid breakout up needs a new high in both price and +DMI (and +DMI must be above 25). Price must make a new low and DMI must make a new high (and -DMI must be above 25) for a down breakout to be valid.

ADXodus ADX Trading Strategy

The ADXodus is a classic power trend strategy that looks for price to break out after a period of consolidation. ADXodus gets its name from the large number of shares that have been accumulated or distributed and are ready to leave consolidation and start a new trend.

Trend’s Basic Idea

  • Momentum precedes price.
  • Get into a trade with no risk and ride the trend.

ADXodus LONG SETUP

  • Price has a pattern with a consolidation period of at least 30 bars (in any time frame).
  • During the consolidation, ADX is less than 25 (preferably less than 15).
  • Before the breakout, both of the DMI lines are above the ADX line.
  • As price breaks the top trendline, the +DMI makes a crossover high.
  • Price goes back to the 20 EMA and stays there (first retracement), while the +DMI makes a pivot low at or near 25.
  • When the price turns up from a low pivot point, buy (up).
ADXodus

Check the image above. 15-minutes chart of Adani Ports share went for a prolonged consolidation in ADX. Then the breakout in ADX and also in the price action happened. You can enter after a small pullback for a good rally.

ADXodus SHORT SETUP

  • Price has a pattern with a consolidation period of at least 30 bars (in any time frame).
  • During the consolidation, ADX is less than 25 (preferably less than 15).
  • Before the breakout, both of the DMI lines are above the ADX line.
  • As price breaks below the bottom trendline, the DMI makes a high crossover.
  • Price goes back to the 20 EMA and stays there (first retracement), while the DMI makes a pivot low at or near 25.
  • When a price’s pivot high turns down, you should sell (down).

Continuations Strategy

After an ADX peak of more than 25, the trend is more likely to keep going than to change. During a retracement, if the dominant DMI stays dominant, a new high on the dominant DMI shows that the trend will continue. New high DMI and a new low price, or a new high +DMI and a new high price. A variation happens when cross DMI lines meet, but DMI dominance doesn’t change.

ADXtender ADX Trading Strategy

The ADXtender is a strategy for staying in a trend after an ADX peak of 25 or more. It gets its name from the fact that a strong ADX pushes prices higher. Some retracings are short and some are long.

Trend Principle

Trends are more likely to keep going in the same direction than to change.

ADXtender LONG SETUP

  • Price goes to a new high, and the ADX goes up above 25.
  • Near the 20 EMA, price goes back down.
  • When the price moves back, the ADX goes down.
  • On the retracement, the DMI does not cross the +DMI.
  • When price makes a new high and +DMI makes a new high, you should buy.

ADXtender SHORT SETUP

  • Price drops to a new low, and the ADX goes up above 25.
  • Near the 20 EMA, price goes back up.
  • When the price moves back, the ADX goes down.
  • The +DMI doesn’t go through the DMI (or crosses slightly without a change of dominance).
  • When price makes a new low and -DMI makes a new high, you should go short.
ADXtender

Watch the Nifty Future chart both in 1-,inute and 3-minute time frame. The ADX indicator was above 25/ -DMI was above +DMI. So the trend is down and trend strength is strong. You can enter in short selling in a small pull back. Best to enter shorts once the low of a green candlestick gets broken.

ADX Trading System - Pull Backs

Watch the chart of Bank Nifty index above. You can trade multiple pullbacks, like the 1st, 2nd or 3rd pullback. But it is always better to trade the 1st pullback.

Suggested Reading

To know about this strategy in more details I suggest you to read the original book ADXcellence: Power Trend Strategies. You can buy the book from Amazon from the book link or click the image of the book below.

Conclusion

Let me summarize and give you 5 salient points of this ADX trading strategy.

  • There is no trend trading during low ADX times
  • Best Trades Begin From Low ADX Periods
  • When ADX peaks above 25, the trend is more likely to keep going than to change.
  • Get out of a trend trade when ADX divergence happens
  • ADX shows when a trend is about to end or change direction.

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