Trade Breakouts with ADX

What is ADX with Directional Movement Index, (DMI)? is an oscillator that measures trend strength shows trend direction.

Advantages of using Average Directional Index (ADX):

works on all timeframes from 1 or higher;

quantifies trend strength;

allows us to see the strength of direction of the market of bulls and bears at the same time;

It analyzes the trend if is strong or weak enough to trade.

Average Directional Movement Index (ADX) was developed by J. Welles Wilder and presented in his book, New Concepts in Technical Trading Systems (1978). ADX is formed from two indicators (developed by Wilder) known as the Positive Directional Movement Indicator (+DMI) and the Negative Directional Movement Indicator (-DMI).

When DMI lines separate—ADX rises, trend strengthening.

When DMI lines come together—ADX falls, trend weakening.

The use of ADX is to measure trend strength. DMI CONFIRMS trend direction and CONFIRMS price entry/exit signals.

When ADX > 20

If +DMI is above –DMI, price is trending up.

If –DMI is above +DMI, price is trending down.

ADX is No directional

ADX measures the strength of a trend, but doesn’t distinguish between uptrends and downtrends.

When there is a strong uptrend, ADX rises.

When there is a strong downtrend, ADX rises.

Breakouts

Point #1

Low ADX Periods—No Trend Trading

ADX Trend Strength Rule

When ADX is above 20, trend strength is strong enough for trend trading strategies

When ADX is below 20, avoid trend trading strategies (optional: scalp trades)

Breakouts

Point # 2

20 Horse Power Minimum

The ADX number for a trend to be “strong” is 20.

When ADX falls below 20, price is usually in a consolidation period and trend trading strategies will normally fail. Once ADX rises above 20, the trader can use trend trading strategies.

When ADX is Below both DMI’s try finding out patterns on the chart.

Price and ADX both generally breakout the pattern together.

ONGC Chart, ADX Below 20 and both DMI’s, Price breakout the triangle and later ADX

confirmed the trend.

In the picture below BankNifty From 04/03/2011 to 23/03/2011was trading in channel On 24th morning we got a breakout with rising ADX.

Breakouts

Point # 3

Best Trades Begin From Low ADX Periods

ADX Trendline Rule

When ADX is below 20 for an extended period, draw trendlines on price and wait for a breakout

DMI Breakout Rule

A valid breakout up requires a new high in price and a new high in +DMI (and +DMI > 20).

A valid breakout down requires a new low in price and a new high in –DMI (and -DMI > 20).

Bank Nifty, ADX below both DMI’s and price is under range, price and ADX both confirmed the breakouts and Price and +DMI started making higher highs.

Bank Nifty, after the earlier trend shown in previous slide, price again entered expanding triangle (pattern), ADX went below both DMI’s, confirms the choppy zone.

Bank Nifty, Last Thursday 28th, finally –DMI made higher high and ADX started rising from 20 confirming the down trend, finally price stopped at previous support.

ADX PullBacks

Point # 4

The Pullback, this strategy is taken from the book street smart, Linda call this strategy

“The Holy grail” , this is a classic power trend strategy that finds price Retracing following a period of trend.

FOR BUYS (SELLS ARE REVERSED)

1. A 14-period ADX must initially be greater than 20 and rising. This will identify a

strongly trending market.

2. Look for a retracement in price to the 20-period exponential moving average. Usually

the price retracement will be accompanied by a turndown in the ADX.

3. When the price touches the 20-period exponential moving average, put a buy stop above the high of the previous bar.

4. Once filled, enter a protective sell stop at the newly formed swing low. Trail the stop as profits accrue and look to exit at the most recent swing high. If you think the market may continue its move, you might exit part of the position at the most recent swing high and tighten stops on the balance.

5. If stopped out, re-enter this trade by placing a new buy stop at the original entry price.

6. After a successful trade, the ADX must once again turn up above 20 before another

retracement to the moving average can be traded.

LICHSNG, 3 times Price came back to the EMA, remember in strong trend price generally retraces 2/3 times

IVRCLINFRA, 3 times Price came back to the EMA, remember in strong trend price generally retraces 2/3 times.