The ADX can be a great technical indicator for identifying the direction and momentum of the trend. The ADX indicator is unique because it can work as a leading indicator that reveals the strength of a currency pairs trend before a breakout move occurs. This makes it a good choice for anyone who is looking to trade breakouts in direction of the overall trend.
What is the ADX?
The Average Directional Index, or ADX for short, is another example of an oscillator indicator just like the stochastic. It is an indicator that measures trend strength rather than direction. The ADX is based on comparing the highs and lows of bars and does not use the close of the bar.
You can find the ADX indicator in most forex trading platforms, including MetaTrader. It is free to use and easy to interpret once you understand what the 3 lines on the ADX represent. The indicator can be used on its own or as part of a more complete forex strategy to further filter signals.
How to use the ADX?
The main ADX line is typically displayed along with two other lines (+DI and -DI). You can combine all three together to help reveal powerful trends.
The main ADX line ranges from zero to 100, usually fluctuating between 10 and 50. The higher the main line, the stronger the trend. Anything above 20 can be considered a trend whilst anything above 50 suggests a strong trend. If the ADX main line is below 20 then there isn’t a prevalent trend and the market should be flat or ranging.
When the +DI crosses above the -DI this is a sign of an uptrend. When the -DI crosses above the +DI, this is a sign of a downtrend. You can look for an ADX cross above the 20 level to identify a strong bullish or bearish trend.
What is the ADX breakout strategy?
When trading an ADX breakout, we are looking to enter a trade when price breaks through recent support or resistance and the ADX is showing a strong trend in that direction. We can also confirm the entry with other technical indicators and price action analysis such as candlestick patterns.
When you enter a good breakout in the direction of the trend, you can catch some big market moves. On the other hand, if it is a false breakout then we can always use the opposite side of support or resistance as an exit point to limit the potential loss on a trade.
Buy signal
- ADX main line is above the 20 level
- ADX +DI is above the -DI
- Price breaches recent resistance level
- Place stop loss below resistance level (optional)
- Exit when the ADX main line goes back below 20 (optional)
You can see in the EUR/USD 1-hour chart below that the ADX +DI was above the -DI showing an uptrend. The ADX main line is also above 20 showing the trend is gathering momentum. Price makes a breakout through recent resistance and there is a morning star candlestick pattern. These all show a strong buy signal which turned out to reach around 300 pips before the ADX main line went back below 20 to show the trend was losing momentum. If the stop loss was placed just below recent support, it would have been around 50 pips. This would have given a risk to reward ratio of 1:6 which is very good.
Sell signal
- ADX main line is above the 20 level
- ADX -DI is above the +DI
- Price breaches recent support level
- Place stop loss above resistance support (optional)
- Exit when the ADX main line goes back below 20 (optional)
In the EUR/USD 1-hour chart below, you can see that price bounced off the support level a number of times. This showed it was strong support which eventually led to a good breakout opportunity. This was confirmed with the ADX above 20 showing a strong trend to the downward direction as the -DI was above the +DI. There were also lots of Doji candlesticks that showed indecision the markets. This trend went on to make over 400 pips and would have been fine with a very tight stop loss.
ADX breakout strategy Pros & Cons
Pros
- Can catch some big trends
- Detect trend direction and strength
- Can be used on any currency pair and timeframe
- Works well alongside other indicators
- ADX indicator is free to use
- Can use pending orders either side of support/resistance
Cons
- Need to filter out false signals
- Requires good money management
- Requires trending market conditions
Conclusion: should I trade the ADX breakout strategy?
Yes, if you are looking to buy or sell currency pairs in the direction of the overall trend, then the ADX breakout strategy can be very powerful. Even more so when combined with additional chart analysis. I personally would not use the ADX on its own and you will need to know how to mark support and resistance on the charts. If you don’t feel comfortable doing this, you could always use an indicator such as the Bollinger bands to help spot breakouts.
No matter how good any forex strategy is, you will also need to have your money management in check. I would want to use a favourable risk to reward ratio so one bad trade does not wipe out a run of winners. For this reason, I would try to cut losing trades short rather than hold on to them hoping they will turn back around. I might even lock in good trades at break even point and trail the remainder of the position to try and get the most out of big trends.
If you want to give the ADX breakout strategy a try, you could always start on a forex demo account. You can get a free demo account from most forex brokers including IC Markets. They have tight spreads on a great selection of currency pairs which you can trade with low commission fees and ECN execution speeds.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
