Whether you want to identify and follow trends, filter out noise, confirm breakouts and breakdowns, the average directional index is a helpful technical analysis tool that will help you out.
Here’s a comprehensive guide on what is the ADX, how it works, and how to use it and interpret its values when trading crypto assets.
What is The Average Directional Index (ADX)
The average directional index (ADX) is a momentum technical indicator that measures a trend’s strength level in an asset’s price, including cryptocurrencies.
ADX’s core theory is that trading when the market is moving toward a strong trend increases the chances of profit and significantly reduces the risk.
The key components of the ADX are:
- Positive Directional Movement (+DI): measures the strength of upward price movements; when +DI rises, it suggests a bullish trend is gaining momentum.
- Negative Directional Movement (-DI): gauges the strength of downward price movements, indicating a bearish trend when it surges.
- Average Directional Index (ADX): a smoothed average of the +DI and -DI values; it provides a single value that reflects the overall strength of the prevailing trend.
How Does the ADX Work?
The ADX measures the trend's strength on a scale of 0 to 100, with higher values indicating a stronger trend.
The ADX first calculates +DM (Plus Directional Movement), the -DM (Minus Directional Movement), and the true range (TR) for each period (usually 14 periods). Then, it smoothes versions of +DM and -DM, which are then divided by a smoothed version of the true range.
The end result reflects a trend’s true strength level.
How to Interpret ADX Values?
Here's a breakdown of ADX values:
- 0-25: indicates a weak trend or a sideways market.
- 25-50: suggests a moderately strong trend.
- 50-75: shows a strong trend
- 75-100: indicates a very strong trend
*Important note: the ADX can be a valuable metric for identifying emerging trends in crypto, but it doesn’t signal when a buy or sell opportunity occurs.
The ADX indicator simply tells you if it's worth investing in an ongoing trend or not by assessing the strength of the trend lines.
Using ADX in Crypto Trading
Here are useful tips on how to leverage the Average Directional Index for effective crypto trading:
Identifying trend strength
One of the primary uses of ADX is to identify the strength of a trend. The ADX value typically ranges from 0 to 100. A high ADX value, say above 70, indicates a strong trend, whether bullish or bearish. Conversely, a low ADX value, below 20, signifies a weak or ranging market.
Confirm trend direction
Besides measuring trend strength, ADX can also help confirm a trend’s direction. When +DI is above -DI, it suggests a bullish trend, and vice versa for a bearish trend. Traders often look for crossovers between +DI and -DI as potential entry or exit points.
Use ADX as a filter
Crypto traders often use ADX as a filter to enhance their trading strategies. For instance, if you're employing a trend-following strategy, you might only take buy signals when ADX is above a certain threshold (e.g., above 25), ensuring that you enter trades during strong trends.
Evaluate the momentum of a breakout or a breakdown
If the price of a crypto asset breaks above a resistance level, traders can use the ADX to confirm that the breakout is valid and likely to continue. A rising ADX above 25 suggests that the breakout has strong momentum and that traders can enter long positions or add to existing ones. But if the ADX is falling or below 25, it suggests that the breakout is weak and that traders should be cautious or wait for further confirmation.
Combining ADX With Other Technical Indicators
ADX and Exponential Moving Average
Combining the ADX with moving averages, specifically the EMA (Exponential Moving Average), can yield remarkable results. ADX can tell you if the market is trending or ranging, and EMA can show you the trend’s direction and momentum.
Traders often look for the "Golden Cross" (bullish trend) and the "Death Cross"(bearish trend) to make trading decisions.
For instance, an EMA above 20 can suggest a buying point. But as EMA can sometimes show false signals, ADX can help eliminate these signals if the ADX line crosses above 20 as well.
ADX and RSI
The Relative Strength Index (RSI) is another invaluable tool to complement the ADX indicator in your crypto trading strategy. RSI measures the speed and change of price movements, helping traders identify overbought or oversold conditions.
RSI values above 70 indicate overbuying, while values below 30 suggest overselling. Traders look at the RSI level to find the reversal and use ADX to measure the strength of the reversal.
ADX and The MACD
With the Moving Average Convergence Divergence (MACD), you can use its histogram to see a trend’s direction; values above zero suggest a bullish trend, while values below zero translate as a bearish trend. Combining MACD with the ADX increases the accuracy of your trading prediction. For instance, if the MACD histogram is above zero, the ADX should be above 25 to confirm the buy trade; but you’d still have to check if the +DI crosses over the −DI for a stronger confirmation.
Conclusion
The ADX is a versatile tool that helps with decision-making even in the highly dynamic world of cryptocurrencies. Based on how strong a trend is, you can use the ADX to determine the best time frame to trade. Like any other technical indicator, it’s better to use it in combination with other indicators to elevate your crypto trading strategy.
Additionally, you can use a crypto trading platform like Altrady. If you’re looking to delve into the analysis of ADX signals, Altrady sets a very simple path: set up an account, choose your preferred exchange, and activate the Average Directional Index indicator.
With Altrady at your disposal, you gain the ability to seamlessly oversee and trade assets across multiple exchanges, all facilitated by user-friendly tools.
