Active Trader Magazine
  


Trading Strategies

ADX breakout scanning

By Ken Calhoun
Spotting volatility breakouts that are likely to continue can be daunting. The Average Directional Movement Index (ADX) — an indicator that measures trend strength — can help. The ADX is unique because it can work as a “leading indicator” that reveals the strength of a market’s trend before a breakout move occurs.

The main ADX line is typically displayed along with two other lines — the Directional Movement Indicators (+DMI and -DMI) — and the three can be used together to help reveal strong trends. The main ADX line ranges from zero to 100 (the higher the reading, the stronger the trend) and usually fluctuates between 10 and 50. Readings below 20 reflect trendless conditions — consolidations that should be avoided.
  
An ADX above 40 indicates a strong trend or breakout is in progress, and price is likely to continue in the direction of the current trend. Because the ADX measures trend strength rather than direction, the ADX line will move up sharply during sell-offs as well as up moves.

Crossovers of the DMI lines are not important; rather, it’s critical to see the ADX breakout above 40 and do so above both +DMI and -DMI lines at the same time.

In Figure 1, for example, strong breakouts occurred when the ADX broke out above 40 on Dec. 14 and 18. This is the single most valuable use of the ADX indicator: as a leading indicator on multi-day charts to help spot potential breakout continuations after an ADX reading above 40 occurs.



For the complete article, see the April 2010 issue of Active Trader magazine. Click here to subscribe.



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