Trading the BSE with the ADX
ADX is an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend.
The indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. A reading above 40 can indicate a strong downtrend as well as a strong uptrend.
First Some History J. Welles Wilder developed the Average Directional Index (ADX) in order to evaluate the strength of the current trend, be it up or down. It's important to determine whether the market is trending or trading (moving sideways), because certain indicators give more useful results depending on the market doing one or the other. In other words the ADX attempts to measure the strength of the direction the security is moving in. |
The reason we mention this is that many of our students get confused when first introduced to ADX and see the indicator rising as the trend goes down. A rising ADX means a strong trend, whether it be bullish or bearish.
In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI. Be careful, though; when a security is in a trading range, this system may produce many whipsaws. As with most technical indicators, +DI/-DI crosses should be used in conjunction with other aspects of technical analysis.
Below is an hourly hart of the BSE Sensex showing +D crossed over above -D and the Black Index line of the ADX indicator also crossing above a reading of 30 (Thin blue line) indicating a strong trend.
Advanced Method As mentioned previously you should use the ADX in conjunction with other aspects of technical analysis. We like to use the ADX (14 setting) together with Bollinger Bands (20 setting). Below is the same hourly chart of the BSE Sensex, now with the Bollinger Bands drawn in and indications of where we like to normally enter and exit the market using this trading strategy: |
Trading Rules:
- Plot the Average Directional Index with a setting of 14
- Plot Bollinger Bands with a setting of 20
- Confirm a reading above 30 on the ADX - Green Index Line, also a cross up of +D over -D.
- Enter on the first candle closing OUTSIDE the top Bollinger Band line after the ADX has signalled (Green arrow)
- Exit on the first candle that closes below the top Bollinger Band line again (Red arrow)
- Keep your stop tight below the last candle that closed on/below the middle Bollinger Band line.
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The Indiadaytrading.Com Team
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Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument.