This is Season 3 Week 7 of Steemit Crypto Academy and I'm writing Homework Task for Professor @kouba01
Question. 1)
Understanding of the ADX indicator
&
How it is Calculated?
There are various technical analysis indicators available in trading charts at different platforms one of the commonly used indicators is the ADX indicator. It stands for the Average Directional Index. It is used to determine the strength of a trend and various traders use it as an integral part of their technical analysis.
The ADX indicator is often used with a combination of two lines to indicate whether the trend is upward or downward. These lines are referred to as the directional indicator lines. The details of these lines will be discussed later in the post.
The ADX indicator was designed by Welles Wilder for the daily commodity charts. It is now prevalent and is largely used by crypto traders for judging the strength of the trend. The important levels in the ADX are
0-25: No trend or very weak
25-50: An indication of the existence of the trend in the market
50-75: Trend is relatively strong but can be stronger
75-100: the indication of an extremely strong trend
Non-trending may not necessarily mean that the price isn’t moving
This scale was set by the founder according to whom a market is trendless if ADX is below 20. At many times the price is moving but the ADX does not show a trend. This is because the trend is too short or the market is too volatile to rely on and hence the indicator indicates not to apply any trade. AS the trend becomes stronger the ADX increases.
Non directional behavior:
From this point we incurred that ADX is non-directional; it does not move in compliance with the market. ADX can move down even if the market is up trending. It is because the ADX line only shows the strength and not the direction of the market. So a falling ADX line represents the decreasing strength of the trend and not the reversal of trend.
The DI lines
When ADX is added to the chart we see two more lines the DI+ and DI- these are positive and negative directional indicators respectively. As ADX does not tell us about the trend direction , these lines help us clearly understand the direction as well as the strength of the trend.
Calculation
We follow the following steps to calculate the value of ADX
We have a total of 14 periods by default in various renowned trading platforms such as tradingview on coinmarketcap.om. Overall we have to calculate +DI, -DI, and the true range (TR) for each of the 14 periods or we can also use a simplified method given below:
True range is calculated by
Current high minus current low
Current high minus previous close
Current low minus previous close
The highest value among all these answers is said to be the true range
Calculation of the DMI
+DMI = current high - previous high.
-DMI = previous low - current low.
If any one of these is negative, then the final value by default will be zero.
The final Directional index is calculated as:
DI+ = DMI + / TR
DI - = DMI - /TR
DX = | +DI - DI - | / | +DI + DI +|
DX is the directional index and TR is the true range
Formula of the ADX:
ADX = Number of period (n)× (DX) / number of period (n)
n= number or periods
DX= Directional Index
Example
Suppose in any currency, Hypothetical values for the current high, low, Previous high and low are:
Current high = 21.50
Current low = 18.50
Prev. High = 17.50
Prev. Low = 14.00
Prev. Close = 15.50
Period =1
DMI will be calculated as:
DMI+ = (21.50 - 18.50)
DMI+ = 3.00
DMI- = (14.00 - 17.50)
DMI- = -1.50
DMI+ is higher than zero and the DMI- is less than zero then
DMI+ =3.0 and the DMI- =0. (as was a negative value)
Calculation of the True range
TR = Max[(21.50 - 18.50); (21.50 - 15.50); (17.50 - 15.50)]
TR =Max [(3.0); (4.0); (2.0)]
The True range Value TR = 4 as it is the highest value of all the above
The directional indicator
DI+ = 3 / 4
DI+ = 0.75
DI- = -1.5 / 4
DI- = -0.375
Calculation of the ADX Line
ADX = 1 [((0.75) - (-0.375) / (0.75) + (-0.375)] / 1
ADX= 3
Question. 2)
Adding ADX, DI+ and DI- indicators to the Chart
To add the ADX indicator, go to the coinmarketcap.com, click on any coin and then click on charts to see the tradingview chart on Coinmarketcap.
In my case, I opened BTC/USDT chart
- Go to the indicators option on the top panel
- Search DMI in the search bar
- Click on Directional Movement Index to add it in the chart.
At the bottom of the chart you will notice three lines one of them is the ADX and the others are DI+ and DI-.
Best Settings of ADX
By default we have a period length of 14 periods. According to many traders it is the ideal period length as with it the ADX line gives accurate rises and falls indicating the strength of the trend correctly. Shorter periods’ line is disrupted and has greater frequency of giving false signals; the longer periods’ line is very feeble and flat and hence is also not very ideal.
But we can see in the chart above that the ADX line is in compliance with the trend. It is not very wavy; it indicates the change in trend of their strength accurately. However we are using the DI lines to see the direction of the market for better results.
Question. 3)
Do you need to add DI+ and DI- indicators to be able to trade with ADX? How can we take advantage of this indicator? (Screenshot required)
Adding the DI lines to the ADX indicator is not necessary. But their addition facilitates the trader in understanding the direction of the market. Many traders do not find it reliable to only trade by adding the ADX as it only indicates the strength and not the right direction.
DI lines add value to the accuracy of the indicator in getting us the right buying and selling signals. The price action of the trend can also indicate direction but the addition of DI+ and DI- is the confirmation of the price movements.
Bullish or bearish trend indication
The interaction of these lines validates an uptrend or the down trend. When the DI+ line is above the DI- it indicates the bullish trend and the opposite is true for the bearish trend.
The quantification of the strength of the trend
The ADX line on the other hand indicates how strong the trend is. The peaks in the ADX indicator are formed when the trend is strong. The flatly moving line indicates a weaker market.
The use of DI and ADX lines for buy and sell signals
The crossovers of the DI+ and DI- lines are one of the many indications that traders use to place buy and sell signals. When the DI+ line crosses the DI- line and continues to move above it is a buy signal. This buy signal can be confirmed by looking at the ADX line if at the time of the cross the ADX is above 25 then this is a valid trend otherwise the signal is not followed. The opposite setup is used for the selling signal in which the DI+ crosses the DI- line to move below it and continues to move under it. such a trend can also be confirmed by its strength looking at the ADX line.
As in the chart of BTC/USDT above we can see a bearish crossover but the ADX line is very close to 25 and hence it is not a reliable sell signal.
Question. 4)
Different Trends detected using the ADX?
ADX helps us recognize different strengths of trends in the market. It helps us differentiate between a weak, strong, very strong and an extreme trend.
A weak trend
ADX is a quantitative indicator; its value is the direct indication of the strength of the trend. When the value of ADX is 25 or below it the trend is weak or else there is no trend at all. This does not mean that the price is not moving, rather the price is rapidly fluctuating between the support and resistance levels and the market is not supported by buyers and sellers.
In this case the buying and selling does not yield profits and in most cases the traded amount drags us in loss as the market can be seen in a consolidating phase. When the market comes out of the consolidation phase it forms a successful trend depending upon the price breaking the support level or the resistance level.
Strong trend
As soon as the ADX line moves above the level of 25 the market enters the strong trend. Although this is not an indication of aggressive trend strength yet most of the strong trends lie in this range. The range of ADX for a strong trend is 25 to 50. The BTC.USDT chart below shows a strong trend.
Very strong trend
We rarely see an inclination in the trend of the market. It is when the side of the traders either or buyers or sellers are trying to take control of the market. The range for the ADX here is 50 to 75. The chart below illustrates a very strong trend.
Extremely strong trend
Rarely do we see when one side of the trend is completely in control of the market and the ADX line remains below 100 but above 75.
Filter the false signals:
As we comprehend from up till in the post that ADX is only accurate in indicating the strength of the trend and not the right sell and buy signals therefore care must be taken while using it. In order to avoid false signals first of all we should use a moderate period such as that of 14. Shorter and longer periods increase the chances of comprehending wrong trends.
When the periods are short the ADX line shows so much fluctuations and thus potential chances of false signals increases. In very large periods too the right trends of the market are not visible. Secondly we can use a combination of indicators such as using trend lines.
As in the chart above, I draw a trend line to check the trend. The overall trend was bullish but ADX showed a dip.
Question. 5)
Explain what a breakout is. And How do you use the ADX filter to determine a valid breakout? (Screenshot required)
Breakout as the name indicates the shift of the market from one trend to the other. It is a general term that traders and investors use to describe the movement of the price above the level of resistance and below the level of the support. The breakout point can be an indication of the market gaining momentum any time soon.
The ADX indicator helps us recognize valid breakout signals. Traders ignore those breakouts which occur at the level below the level of 25 as the trends under this level are weak to continue their breakout.
In the chart above, we see a valid breakout as the ADX indicator can be seen to oscillate above the 25 level.
Question. 6)
ADX indicator for Scalping & for Swing Trading
For scalping:
For scalping with ADX we will have to:
Use shorter periods of ADX as the traders trade in shorter time frames of 5,10, and 15 minutes
The ADX line is more wavy and has a high oscillating frequency
It detects and shows even minor and false breakouts and trends
It is not very reliable unless not used with other indicators
Traders first use reliable indicators to mark the right support and resistance levels and then use ADX for the confirmation of the strength of the trend
For swing trading:
Traders trade on longer time frames of hours, days, and even weeks and months
For Swing trading we can use longer periods of ADX
It is more reliable as in the longer time frames we can use long periods of ADX such as the multiple of 14
Longer periods ADX line engulfs the false signals gives us reliable trend strength
In my view, although ADX can be used for both scalping and swing trading, the traders must be very careful to avoid false signals. In addition to that, using it for swing trading is rather safe and better in determining the right buying selling signals and strength of the trends.
Conclusion
ADX is a very popular trading indicator as in terms of providing strength of the trends it is reliable. It is used by a large number of traders worldwide when they design their technical analysis.
While working with the ADX indicator, One must be very careful as not to confuse its rising and falling with the direction of the market. The rise in ADX indicates that a trend is strengthening whereas a fall indicates that the trend is weakening and not the market direction.