Combining ADX with Other Indicators | Using ADX with Complementary Trading Tool

The Average Directional Index (ADX) indicator is a simple tool to measure the strength of a trending market cycle. J. Walles Wilder, who created the ADX, also developed the RSI and the Average True Range, whose calculations correlate closely with the ADX.

In this article, traders will understand such correlation and explore multiple combinations as the simplicity of ADX enables it to enhance its signals by effectively integrating it with other indicators like Bollinger Bands, MACD, and DMI.

ADX Trading: How it works

By its sole implementation, ADX seeks strength information. It accomplishes such a task by varying from 25 to 100 values, where those situations above 25 values indicate a price likely to trend. Otherwise, values below 25 suggest trendless market conditions.

Although it stands for directional movements, it does not focus on where the price of an asset is going but on how much strength that movement carries. This simplicity allows this indicator to work effectively in combination with other indicators.

For instance, the calculation performed by ADX is based partly on a True Range, which can help traders deal with volatility. Likewise, by integrating DMI, traders can also analyze price directions.

To discover range conditions and seize subsequent momentums, the Bollinger Bands can assist ADX by combining the analysis of narrowing and expansion movements alongside the calculation of the underlying volatility of a market.

Regarding market tops and bottoms, the divergence concept can accompany the ADX with the help of MACD and RSI indicators, which adds a plus to the effectiveness of detecting turning points in the price.

Understanding ADX and DMI

By default, ADX displays one line ranging within its inner values to measure strength primarily. The typical combination for unveiling directions is integrating the Directional Movement Index (DMI).

The DMI is indeed a later modification introduced for the ADX. In this case, the DMI integration would plot some more lines:

1. +DI = current high - previous high (green).
2. -DI = previous Low - current Low (red).
3. DX = the directional index based on a 100 times Exponential Moving Average of the coefficient value from dividing +DI (-) -DI / +DI (+) -DI.
4. ADX = the strength index (white) resulting from averaging the DX and smoothing it by multiplying the values by the specified period for the ADX and dividing the total by the same period (14).
5. ADXR = the R stands for "rating," which implies a calculation over the current ADX and the ADX from 14 periods ago to obtain a new average result.

But how do technical analysts read these indications?

• By spotting crossovers: The +DI crossing above the -DI indicates upward trends. Similarly, the -DI crossing above the +DI indicates downward trends. Note that both crosses are "above," unlike other indicators which perform below crossovers. The negative and positive symbols determine the directions.
• By measuring strength: The ADX and ADXR indicate the strength of the spotted crossovers, either up or down, where values over 25 indicate weakness and close to 100 pinpoint strong trends.

Now, it is pertinent to clarify that the most extended way traders use DMI is by plotting just the +DI, -DI, and ADX lines, as this is a straightforward mode to spot signals. DX and ADXR can be complementary lines for analysis confirmation.

Red line = -D. Green line = +D. White line = ADX

Addressing Volatility With Bollinger Bands

As noted before, the ADX (and more certainly the DMI) works on a True Range basis. Similar to the Average True Range indicator, this characteristic helps traders assess market volatility.

By integrating the Bollinger Bands, a volatility indicator but not an oscillator-type tool, traders can compose an advanced technique to handle and exploit sharp price movements for breakout strategies and trend trading approaches.

Likewise, when the ADX indicates trendless conditions, Bollinger Bands can offer a clearer view of a range market in the chart when their bands narrow and the end of the range when they expand.

The procedure for this advanced technique would be as follows:

• When the ADX moves in trendless values (20-25-30), the Bollinger Bands would confirm such a condition by narrowing.
• When the ADX moves towards trending values (50-75-100), the Bollinger Bands would confirm such a condition by expanding.
• The more the bands narrow, the less momentum in the market.
• The more the bands expand, the stronger the momentum in the market.

As those narrowing, expansion, trendless, and trending conditions change rapidly across bullish and bearish directions, they reveal insights into the underlying volatility affecting the current market price movements.

Capturing Turning Points: Divergence With RSI, MACD And ADX

Divergence is a popular technical analysis concept among several indicators, such as MACD, RSI, and even volume tools for spotting reversal price movements.

The case of RSI for divergence deserves special mention here since J. Welles Wilder, who developed the ADX, also developed the RSI, which measures the relative strength of a price level, primarily suggesting overbought and oversold conditions.

The case of MACD also plays a significant role since it is a trend-trading tool that can follow the market across several swings and pullbacks. While the ADX assesses the trend strength, with MACD, both can reveal potential reversal swings in a directional market.

The central idea is that a lack of correlation between the price direction and what an indicator is signaling will lead to a turning point in the market. In this meaning, traders can look for the following scenarios:

• The ADX divergence implies a higher swing (uptrend) or a lower swing (downtrend), while the indicator makes a lower high since the ADX is not a directional indicator.
• RSI can add a sense of direction while spots overbought and oversold levels, adding a layer of confirmation.
• MACD can anticipate the total end of a trending cycle by revealing a decrease in the strength alongside a declining ADX as the price loses correlation through various divergence swings

Conclusion

Since the ADX performs a simple procedure to measure the trend strength of an asset, it leaves room for effective combination with other indicators.

Such is the case of DMI, which was born from the necessity for directional signs.

Since ADX performs a True Range calculation, it also helps analyze volatility. By integrating Bollinger Bands, traders can detect ranges. Reversal swings are another movement that ADX can seize; the RSI and MACD are the perfect indicators to enhance the accuracy when finding turning points through the divergence concept.

In Altrady, using ADX, DMI, Bollinger Bands, RSI, and MACD is as easy as signing up for a free trial account today.