You can sum up the secret to using ADX indicator in a single word: SLOPE.
Most traders learn that ADX is a robust system that tells you if the market is trending. The typical interpretation is that if ADX is above 25, the market is trending. If ADX is below 25, the market is meandering without direction. (You can also use ADX as a low-risk day trading trigger with the 2-period ADX.)
While the value of ADX is significant, the slope of ADX is also a valuable tool. After all, for ADX to move above 25, it must first tilt up.
Hence, the ADX slope will be positive even before it crosses 25. This change of slope gives us an early signal to a trending market. Similarly, when ADX slopes down, the market might be entering a trading range.
In a nutshell, paying attention to ADX slope compensates for the lagging nature of the ADX indicator.
Interpreting ADX Slope
Rising ADX slope means trending market
The background color of the chart is green when ADX is rising and turns red when ADX is falling. (I used the Chart Background Color Indicator for this.)
Looking at the ADX slope gave earlier signals to a trending market. The ADX slope turned positive at two points that hinted at a trending market.
If we had waited for ADX to rise above 25 to confirm the trend, the signal would come almost a month after the first hint from ADX slope.
Of course, the ADX slope is no Holy Grail. ADX slope changes directions frequently and is more prone to giving false signals. However, if you pay attention to the price action together with the slope of ADX, you can cut false signals reliably.
This is how you do it. When prices are moving in one direction, the slope of ADX should stay positive. Look at the downswing near the left-hand side of the chart. During that downswing, prices are falling, but ADX slope fluctuated up and down. So we ignore those signals.
Compare this to the first hint of the uptrend that we pointed out. Prices have risen before the change in ADX slope. Prices continued to increase with ADX sloping up for consecutive bars. This is a more reliable sign that a trend is in place.
Falling ADX points to Ranging Market
Once we confirm that the market is ranging, be doubtful of positive ADX slope signals as failed breakouts are common. Unless the positive ADX slope comes with a definite breakout from the trading range, assume that the breakout will fail.
Bollinger Bands are useful for estimating the support and resistance levels within the range. The Gimmee bar trading strategy uses Bollinger Bands to trade ranging markets. Employing the ADX slope to scan for sideways market before looking for Gimmee bars is a good idea for swing traders looking for trade opportunities.
ADX Slope is not a well-kept secret
Okay, I must confess. Using ADX slope is not that much of a mystery. (In fact, please be doubtful of any trading secrets, especially those that cost you $3,000 each.)
Several advanced users of ADX has discussed using the ADX slope for trading in forums and trading books. I shall redeem myself by listing them here for you.
- Why ADX > 20 is a Lie discussion on Traderslaboratory
- Direction is the Key to Using ADX Correctly
- ADXcellence: Power Trend Strategies
Keep practicing and make the most out of this fantastic indicator.