Using ADX : Wilder's Average Directional Index

by Ken Calhoun

April 9, 2017

If you're like a lot of traders I work with, you sometimes hesitate before getting into a new trade. This can be really frustrating when you see the stock or ETF you were about to enter skyrocket up without you, right?

Finding a useful "confirming entry signal" that's easy to use was always a challenge... until the ADX came along. It's the only "lagging indicator" that tells me what to trade... ahead of time!

That's right...I've found that when the ADX indicator breaks over certain signal levels, breakouts often continue and provide great trading setups you can use over and over again.   I put my own real money on the line every week with real trades — and I've tested out my techniques for using the ADX as a leading indicator extensively, for many years.

One main challenge my traders tell me about is the difficulty they have in spotting what's genuinely volatile BEFORE it makes a big move (whether that's a stock or an ETF)...

ADX Breakout Strategy:

I like to wait for the day after ADX moves over 40, before entering a new swing trade.  This strategy is not for risky small-caps nor penny stocks; it is for stocks priced $20 - $70/share. I use a 15-day 15-minute candlestick chart for swing trades.

When it comes to using the ADX, keeping it simple is important, by focusing your attention on the strongest charts, like this one below:

What is the Average Directional Index (ADX)?

The ADX is used to help measure the strength of a trend.  Classic usage defines a strong trend as when ADX > 25, and includes the use of Directional Movement indicators (DMI).  The ADX was developed by J. Welles Wilder.

Our usage is a modified one with ADX > 40 as a breakout signal on a 15-day chart, and no DMI lines needed.

Average Directional Index : Trading Tips

The ADX acts like a volatility indicator to let you know when price action is getting stronger over time.  Here's a few tips that can help you when swing trading with this indicator:

  • Do not be impatient and enter too early: the ADX must break out and hold above 40 on the day prior to entering your position.
  • I like to swing trade volatile 15-day charts with at least 10% range from high to low: so for example a $30 stock must have at least a 3-point high-low range on your 15 day chart.
  • When swing trading with ADX breakouts, I always consider adding to my winning trades once it has moved up at least 2 points in my favor.  Scaling in (aka "position sizing") is a valuable technique.
  • Look for increasing volume on the day you enter as a bullish confirmation secondary signal.

I hope this helps you in your swing trading -- best wishes for upcoming success with the ADX!

 

Ken Calhoun, Founder
TradeMastery.com

Setting Up ADX In Your Charts

Configuring your charts to use ADX is simple.  I use a standard 14-step parameter.

One advanced tip is to remove the Directional Movement Index (DMI) lines by setting their color to the same color as your chart background (I use white myself).

I only focus on following the main red ADX signal line.

RELATED RESOURCES

Here's several articles I wrote on trading with the ADX:

Technical Analysis of Stocks & Commodities: ADX Breakouts (subscribers)

Fidelity:  ADX Breakout Scanning

eSignal: ADX Volume Breakouts

also see
ThinkorSwim: ADX Breakouts Filter

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