Speculating in the foreign-exchange, or forex, market allows traders to profit from small moves in the price of currencies. You trade currencies in pairs: the U.S. dollar against the euro, for example, or the Japanese yen against the Swiss franc. Many forex traders rely on technical indicators to reveal probable future moves in currency pairs, and one of the more popular signals is the Average Directional Indicator, or ADX.
Open a chart of the currency pair you're trading. Charts are set up in time increments, from extremely long periods of one week or one month, down to one-minute intervals and even "tick" charts that move with every change in price. As the interval expires, the chart will show the rate of exchange between the two currencies, as well as (with a bar chart) the range of that rate over the last interval. A EUR/USD chart, for example, gives the number of U.S. dollars needed to buy a euro.
Bring up the ADX indicator, according to the instructions or Help section provided with the chart. The indicator appears as a solid line underneath the price chart. The vertical axis of the ADX chart shows the indicator's strength scale, from 0 to 100. You will notice that the indicator moves up and down, much like a price indicator. But the ADX does not indicate price or rate - instead, it shows you the strength of any trend in the exchange rate, as the rate rises or falls.
Watch as the ADX fluctuates. The lower the ADX indicator, the weaker the trend - either up or down - in the currency pair. (Note that ADX can also be used with stock price charts and works the same way.) As the ADX rises, the trend strengthens. Above a reading of 25, the ADX shows that the pair may soon be entering a strong trend.
Compare the chart you are looking at to charts at longer time intervals. If the ADX is moving through 25 and toward 30 on these charts as well, the trend that is developing is confirmed over different time frames, lending support to the indicator. Once the ADX tops 30, the pair is in a strong trend. Trade with this trend in the dominant direction of the pair to improve your chances of a profitable trade.
- Use the ADX in combination with other directional indicators to get more perspective on the price action. Remember that ADX does not indicate "buy" or "sell" at any specific point; instead, it reveals the relative strength of any trend affecting the currency pair you're trading.
- Don't rely on ADX alone to determine your trades. Other factors affect the success of currency trading, including volatility, technical support and resistance and time of day. Also, pay close attention to news announcements that can drastically change the direction of a currency pair.
Items you will need
- Forex trading account
- Forex price chart showing ADX indicator
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