ADX Indicator: Discover What’s Trending in the Crypto Market
Cryptocurrency traders often find it difficult to determine whether a trend will extend or reverse. On the other hand, buying a crypto asset within a strong bullish trend is more likely to provide profits. Therefore, it’s crucial to know how to find a price movement’s strength. Traders can find the best buying point by applying a good combination of technical indicators. Based on studies, the market trends less than 30% of the time. With these trends ranging from strong to weak, it’s important to have an indicator like the Average Directional Index (ADX) because it helps with judging the strength of the trend.
The ADX indicator can help traders identify a trend’s power, reducing their number of trades and increasing accuracy. In the following section, we’ll examine the ADX indicator in cryptocurrency trading and look at ways to combine this tool with other technical indicators such as MACD, RSI, EMA and Fibonacci retracement.
What Does ADX Indicate?
The ADX indicator shows the strength of a trend by combining a trend line with a pair of directional movement indicators which accompany it. ADX is usually shown in a separate window below a price chart, and oscillates from 0 to 100. The negative directional indicator (−DI) and positive directional indicator (+DI) are assigned red and green colors, respectively, in order to determine a trend’s strength. ADX is used by traders to determine the strategy and validity of their trading decisions.
In addition to the negative and positive (red and green) lines, the ADX line itself is shown in black. Traders anticipate the strength of an underlying trend by evaluating the relationship between the red, green and black lines. Although this indicator aims to identify the strength of a trend, it also helps traders plan their entry and exit points — or whether even to make a given trade. This trading tool is a valuable price indicator for day traders, scalpers and others.
The application of this indicator is straightforward, although beginning traders might struggle with the complexity of separate lines in different colors. Understanding the elements and calculation method of the ADX indicator can help traders in applying it.
ADX is based on a moving average where the price range expansion is shown for a certain period. In other words, it defines the average of the directional index (DX) for a particular time. In most platforms, the default period is 14 days, but traders can change this according to their needs. The calculation method of this indicator is complex, but it’s worth it for traders to familiarize themselves with the derivation of its formula.
In this calculation, +DM represents the difference between the current high and the previous high, and −DM indicates the difference between the previous low and current low. Meanwhile, ATR refers to the Average True Range.
In cryptocurrency trading, prices can move faster than in traditional financial markets, where finding a trend would potentially bring more predictable profits. As a result, crypto traders can anticipate the future price with less risk and higher returns using the ADX indicator.
Pros and Cons of ADX
Most professional traders use the ADX indicator as a tool to gauge market trends. However, as with other technical indicators, it’s not a complete solution. Therefore, it’s essential to know when the ADX will work and when it won’t. Let’s look at the pros and cons of using the ADX indicator.
- Highly reliable technical tool used to define the market trend.
- Helps traders to define the most profitable trend.
- Accurately quantifies the strength of a trend.
- ADX can confirm the validity of a trend breakout.
- Works well with other technical tools for any trading instrument.
- Can work well in both bullish and bearish markets.
- ADX is a lagging indicator.
- It often provides a false signal in a sideways market.
- The best use of this indicator is obtained by combining it with other indicators.
How to Use the ADX Indicator
The positive and negative indicators of the ADX represent the market trend’s strength by moving up and down. When the positive directional indicator (+DI) keeps moving up, it means the market is in a strong trend. A market trend is getting weaker when the negative directional indicator (−DI) is driving downward.
Focusing on the details of these lines can help you to make a precise trading decision. For example, the ADX moves from 0–100 such that you can divide the range of values into the following categories:
|ADX Value||Strength of the Trend|
The first use of the ADX indicator is from its value. When the ADX value moves up and reaches 25, it tells you that a trend is getting stronger. Therefore, if you’re interested in buying a crypto asset, you can wait for the ADX value to reach 25 before opening the trade. On the other hand, if the ADX value decreases from 80 to 70, the trend is becoming weaker. Another approach is to use the −DI and +DI to increase trading accuracy.
In the above image, the ADX line remains above 20 most of the time, indicating a strong bullish trend. However, the better trading entries come when the ADX line exceeds 20 and pushes higher.
The crossover between −DI and +DI works as an essential trend indicator. When the +DI moves above the −DI while the ADX value remains above 20, we can say that the buying trend is more likely to extend into the future. Conversely, when the −DI crosses above the +DI with the ADX value remaining above 20, we can say that the downtrend is getting stronger, and traders can open sell trades now.
In the above image, the indicators fulfill three necessary ADX trading conditions:
- The market remains within a bullish trend.
- ADX lines push higher, above 20.
- +DI crosses over the −DI and moves above 20.
In addition, traders should focus on the nature of the ADX lines. If they make consecutive higher highs or lower lows, this indicates the trend is stable. Therefore, in a trending market, any trend-following strategy has a greater possibility of providing profits.
In the above 3-day LTC/USD chart, the broader trend remains bullish while some part of the trend remains volatile. For example, although ADX lines remain above 20, they fail to show consecutive highs or lows. As a result, the price moves higher but comes down immediately, which is a sign of volatility.
Another approach is to use multiple time frame analysis to identify the major market trend from daily or weekly charts using the ADX indicator, and open trades based on any trend-following strategy in lower time frames. However, traders should keep in mind that the ADX also works as an indicator of neutral trends. For example, in a volatile market structure, the ADX will move sideways due to insufficient liquidity.
ADX Indicator Trading Strategies
A cryptocurrency market is decentralized, and transactions are conducted through a peer-to-peer network. Therefore, the price of a crypto asset changes according to pure supply and demand, with traders aiming to anticipate future prices based on the use of several technical tools. Since ADX is an indicator which can help increase the probability of trading success, traders are advised to combine ADX with other indicators to generate more profitable trades.
Let’s see how to combine the ADX indicator with some popular indicators in crypto trading.
ADX and MACD
ADX and Moving Average Convergence Divergence (MACD) have the most accurate correlation, as each of these indicators can explain both the continuation and reversal of a trend. MACD helps traders define the trend direction using a histogram that moves below and above the zero line.
When the MACD histogram breaks above zero, we can consider a trend to be bullish. Conversely, when the MACD histogram breaks below zero, we may consider the trend as bearish.
Moreover, we can define the trend’s strength by looking at how histograms are moving. Since it’s a lagging indicator, MACD often shows the market direction after the fact. In this case, the use of the ADX indicator can increase the accurate projection of trade probability.
The MACD histogram should be above zero for a buy trade, while the ADX should be above 25. Meanwhile, if the +DI crosses over the −DI, it will confirm the buy trade.
The above BTC/USD daily chart displays a bullish engulfing bar coming off of the big round number of $30,000. To improve the trading accuracy, we can now combine the MACD and ADX indicators to confirm the potential buy signal. The MACD histogram turns bullish, while at the same time the ADX breaks above 25 and the +DI crosses above the −DI, setting the stage for a rally.
ADX and RSI
Investors use the Relative Strength Index (RSI) indicator to find the possible reversal zone of a trend. When the RSI indicator moves below 30, an asset is considered oversold, and above 70 is considered overbought. Therefore, with this combination of indicators, traders should find the reversal by looking at the RSI level and determining the strength of the reversal using ADX.
In cryptocurrency trading, investors can combine an RSI indicator moving up from the oversold level with a buy indication in the ADX.
The above image shows an ETH/USD H1 chart in which a buying opportunity appears from a support level while the RSI and ADX indicator are both supportive.
ADX and EMA
Exponential Moving Average (EMA) represents the average price of a specific number of candles. The unique feature of EMA is that it considers the most recent price in the calculator that can provide a more accurate price direction than a traditional simple moving average (SMA). Therefore, EMA offers the best result for a lower value. In this regard, we can consider an EMA of 20 as a dynamic support or resistance level.
Thus, in cryptocurrency trading, if the price rejects from the dynamic 20 EMA and closes the candle above it, we can consider it a potential buying point. Note that EMA might provide false signals, as it’s a lagging indicator. Adding the ADX can help eliminate false signals.
In the above image, we can see that the price shows several rejections from the dynamic 20 EMA while the ADX lines are above 20. As a result, the price has been moving higher in a strong bullish trend.
ADX and Fibonacci Retracement
Fibonacci Retracement represents the correction of a trend where the price reverses against the existing trend, but resumes the momentum from certain levels. These levels are known as Fibonacci retracement numbers, and are derived from the Fibonacci sequence. One of the most desirable Fibonacci retracement numbers is 0.618, often referred to as the Golden Ratio. In the investment world, people consider this tool as a highly profitable one since this mathematical pattern is found virtually everywhere in the natural world.
When using this method, traders should find the existing trend first. Later on, draw the Fibonacci retracement lines from swing high to swing low, and see if the price shows bullish rejection at the 61.8% level. Finally, confirm the ADX level above 20 in that area to ensure that the current momentum is strong.
The above image shows that the overall market trend is bullish, when a sudden drop opens a buying opportunity from the 61.8% Fibonacci retracement line. Meanwhile, the ADX is above 20, indicating that the trend’s overall strength is vital.
The Bottom Line
In a nutshell, most of the profit from cryptocurrency trading comes from following solid trends, and there’s no better choice for finding the strength of a trend than ADX. The ADX indicator is one of the most complete trading tools, and can surely benefit any crypto investment decision. The most valuable part of this indicator is that it perfectly pairs with oscillators and moving averages.
Like other technical indicators, the ADX cannot provide 100% accuracy with its signals. Therefore, having proper money management rules to follow is essential to your overall trading success.