3.10 Indicators in technical analysis

Introduction to technical indicators

These indicators are mathematical tools that process price data, volume and other relevant information to provide traders and investors with insights into the health of the market. Technical indicators are a fundamental element of a technical analysis, providing the ability to more accurately assess price movements and trends.
 

Thanks to indicators the traders can:

Assess the strength of the trend: Identifying whether the trend is strong or weak helps in deciding whether to continue a position or close it.

Identify potential turning points: Indicators can signal moments when the market may change direction, which is crucial for trend reversal-based trading strategies.

Make more informed trading decisions: This translates into better risk management and optimization of profits through precise entries and exits of positions.
 

Pros and cons of technical indicators

Pros:

Objectivity: Technical indicators are based on mathematical calculations, which makes them objective tools.

Trading signals: Offer specific buy or sell signals based on analysis of historical data price.

Swiftness of analysis: Allows you to quickly analyze the market situation and make quick trading decisions.

Cons:

Delay: The indicators are based on historical data, which can lead to delays in responding to changing market conditions.

Dependency on market conditions:  Indicators may generate false signals in market conditions with low liquidity or high price fluctuations.

The need for interpretation: Each indicator requires you to understand how it works and interpret the results, which can be difficult for novice investors.

 

Types of indicators

Oscillators: Oscillators are indicators that fluctuate between certain values, often within a range, to show market conditions in the context of an excess of buyers or sellers. Examples of oscillators include the RSI (Relative Strength Index), Stochastic Oscillator or Williams' %R.

Trend indicators: Trend indicators help to identify the direction and strength of a market trend. Examples include MACD (Moving Average Convergence Divergence), ADX (Average Directional Index) or Bollinger Bands.

Volume indicators: Volume indicators analyze the volatility of trading volume in the market. Examples include the Accumulation/Distribution Index (OBV) or the Money Flow Index (MFI).

Understanding technical indicators is crucial for any investor who wants to make well-informed investment decisions in the financial market. Each type of indicator has its own uses and limitations, so it is important to use them properly and integrate them with other technical analysis tools. In the following lessons we will discuss in detail each type of indicator and their practical application in trading strategies in the cryptocurrency market.

 

Key technical indicators

Volume

Definition and meaning in technical analysis 

Volume is one of the key indicators used in technical analysis of financial markets, including cryptocurrency markets. It represents the number of units of a financial asset (such as stocks, futures, or cryptocurrency units) that have been traded over a specific time period. Volume is a representation of trading activity and reflects the intensity of trading in a given financial instrument.

In technical analysis, volume is considered one of the main confirmatory indicators that can support price analysis and identification of potential trend changes.

Interpretation of volume in the context of price changes

Volume interpretation entails analyzing how the changing volume of transactions over time affects the price movements of financial instruments. Here are some key points about volume interpretation:

Increasing volume with rising prices:

An increase in the price of a financial asset with a concomitant increase in volume may indicate confirmation of an upward trend. Increased trading activity suggests that investors are more interested in the asset, potentially leading to a continuation of the price increase.

Increasing volume with falling prices:

When the price of a financial asset falls on rising volume, it may indicate a further weakening of the downtrend. A high volume of transactions at lower prices may suggest that investors are more willing to sell, which may confirm the continuation of the decline.

Low volume during price consolidation:

During periods of consolidation, or price stabilization, low volume can suggest a lack of market unanimity on further price direction. This is often interpreted as a signal that the market is on hold for new trading impulses or information.

 

Practical application: buy and sell signals

1. Confirmation of the trend

Volume is often used to confirm an existing price trend. Here is how it can be interpreted in different scenarios:

Uptrend: While prices are rising, an increase in volume may indicate a strengthening of the uptrend. Traders are entering the market and increasing trading activity, which may suggest further price increases.

Downtrend: When prices are falling, a high volume of sales confirms the downward trend. A high volume of transactions indicates selling intensity, which can reinforce the downward trend.

2. Trend reversal signals

Volume can also help to identify potential turning points in the market, where the trend may change direction. Key situations include:

Caution on trend reversals: If volume is increasing or decreasing in tandem with a reversal in price movement, it may signal that existing trends may be reversed. For example, an increase in volume during price declines may indicate the upcoming end of a downtrend, suggesting a potential opportunity to open a long position.

Diversification: Low volume during a price rise or fall may suggest that the trend is in a consolidation or stabilization phase. This is a period when traders may be waiting for new trading impulses or information that may affect further price direction.

3. Technical signal verification

Volume often acts as confirmation for other technical signals, such as price patterns or momentum indicators eg.:

Price patterns: Confirming candlestick patterns (like engulfing patterns) or trend reversal patterns (like double top/double bottom) with high volume can increase their credibility as trading signals.

Momentum indicators: Confirming signals generated by indicators such as RSI (Relative Strength Index) or MACD (Moving Average Convergence Divergence) with congruent volume can increase confidence in trading decisions.

Summary

Volume is an extremely important indicator in technical analysis, as it helps interpret market activity and trading intensity. Understanding how volume works in the context of price changes and how it can be used to generate buy and sell signals enables traders to make more informed trading decisions. It is a tool that assists not only in identifying trends, but also potential turning points in the market, which is crucial to a successful trading strategy.

 

Relative Strength Index - RSI

1. Definition and meaning in technical analysis

The Relative Strength Index (RSI) is a popular oscillator used in technical analysis, which measures the speed and price movements in the financial market. Its main purpose is to determine whether a financial asset is overbought or oversold. RSI is expressed as a numerical value on a scale from 0 to 100, on which:

RSI above 70: Signals that assets may be overbought, suggesting potential overvaluation and the possibility of falling prices.

RSI below 30: RSI below 30: Signals that the asset may be oversold, suggesting a potential reduced price and the possibility of rising prices.

2. RSI interpretation in the context of price changes

Interpretation of the RSI is relatively simple:

When RSI rises above 70: This could mean that the market is overbought, suggesting the possibility of a price decline in the near future.

When RSI falls below 30: This could mean that the market is oversold, suggesting the possibility of a price increase in the near future.

In addition, divergence between prices and the RSI can also provide valuable information:

Bullish divergence: When prices are rising, but the RSI is making lower lows, this may suggest that the uptrend is still strong, despite potential corrections.

Bearish divergence: When prices fall, but the RSI forms higher highs, this may suggest that the downtrend is still strong, despite potential bounces.

3. Practical application: buy and sell signals

RSI generates buy and sell signals based on two main methods:

Oversold/Overbought: When the RSI exceeds levels of 70 (overbought) or falls below 30 (oversold), signals are generated to open sell or buy positions, respectively.

Crossing 50: In addition, the crossing above level 50 can be used as a signal confirming a change in trend. For example, a cross of the RSI from 30 upward can indicate an upward price movement.

4. Pros and Cons of RSI

Pros:

Simple interpretation.

Helps to identify market conditions: overbought and oversold.

Can be used in both short-term and long-term strategies.

Cons:

RSI can generate false signals in the period of strong trends.

It needs confirmation by other technical indicators or price analysis.

Summary

The Relative Strength Index (RSI) is an oscillating indicator used by traders to assess the strength and direction of price movement. Understanding its operation and interpreting the signals it generates is crucial to successful technical analysis. RSI can provide valuable data on changes in market conditions, which helps traders make investment decisions based on more information.

 

Bollinger Bands

1. Definition and meaning in technical analysis

Bollinger Bands are a technical indicator created by John Bollinger. They consists of three lines:

Middle Band (Simple Moving Average or SMA): Usually the 20-day moving average, which serves as the basis for the bands.

Upper Band: A line located 2 standard deviations above the middle line

Lower Band: A line located 2 standard deviations below the middle line.

2. Interpretation of Bollinger Bands in the context of price changes

The interpretation of Bollinger Bands focuses on price volatility:

Narrow range: When the bands are close together, it means low price volatility.

Wide range: When the bands are wide apart, it means high price volatility.

3. Practical application: buy and sell signals

Bollinger bands generate signals based on price overshooting:

Touching the lower band: This may suggest that the asset is overvalued, which may be a signal to buy.

Touching the upper band: This may suggest that the asset is overbought, which could be a signal to sell.

In addition, the analysis of band crossings can be used to identify trends:

Crossing up the upper band: It may indicate a continuation of the upward trend.

Downward crossing of the lower band: may indicate a continuation of the downward trend.

4. Pros and cons of Bollinger Bands

Pros:

Helpful in identifying price volatility ranges.

Simple interpretation of buy and sell signals.

Flexibility in application to different financial instruments and time periods.

Cons:

Can generate false signals in times of sideways markets.

Requires confirmation by other technical indicators or price analysis

 

Summary

Bollinger Bands are a technical indicator that helps traders analyze price volatility and generate buy and sell signals based on price crosses of the bands. Understanding the interpretation of signals generated by Bollinger Bands allows traders to make more informed investment decisions, especially in the context of changing market conditions.

 

MACD (Moving Average Convergence Divergence)

1. Definition and meaning in technical analysis

MACD, or Moving Average Convergence Divergence, is an indicator based on the difference between two moving averages (EMA - Exponential Moving Average). It consists of three main components:

MACD line: The subtraction of the (26-day) and (12-day) Exponential Moving Average.

Signal line (signal line): Signal line: The 9-day Exponential Moving Average of the MACD line.

MACD histogram: The difference between the MACD line and the signal line, used to visualize changes in price momentum.

2. Interpretation of MACD in the context of price changes

MACD interpretation focuses on the intersection of the MACD line and the signal line:

Bullish crossover: When the MACD line crosses the signal line upward, it may suggest an upward price trend.

Bearish crossover: When the MACD line crosses the signal line downward, it may suggest a downward price trend.

3. Practical application: buy and sell signals

MACD generates buy and sell signals based on crossovers and histogram values:

Buy signal: Generated when the MACD line crosses the signal line upward (Bullish crossover) or the histogram rises above zero.

Sell signal: Generated when the MACD line crosses the signal line down (Bearish crossover) or the histogram falls below zero.

 

4. Pros and cons of MACD

Pros:

Easy interpretation of buy and sell signals.

Flexibility in application to different financial instruments and time intervals.

Is able to identify changes in market trends.

Cons:

Can generate false signals during sideways markets.

Requires confirmation by other technical indicators or price analysis.

 

Summary

MACD is a technical indicator that helps traders to analyze price momentum changes and generate buy and sell signals based on the intersection of MACD and signal lines and histogram values. Understanding the interpretation of MACD signals allows traders to make more informed investment decisions, supporting the analysis of trends in financial markets.

 

Stochastic Oscillator

1. Definition and meaning in technical analysis

The Stochastic Oscillator is an indicator that compares the current closing price of a financial instrument to its price range over a specified period of time. It consists of two lines:

%K: The main oscillator line, which shows the current price position within a price range.

%D: The smoothed moving average of the %K line, often set to a 3-day period.

2. Interpretation of the Stochastic Oscillator in the context of price changes

The interpretation of the Stochastic Oscillator is based on two main signals:

Exceeding the 80% level: Signals that the market is overbought, which may suggest potential discounts.

A drop below the 20% level: Signals that the market is oversold (oversold), which may suggest potential price increases.

3. Practical application: buy and sell signals

Stochastic Oscillator generates buy and sell signals based on the position of %K and %D and their crossing with each other:

Buy signal: Generated when %K exceeds %D up and is below the 20% level.

Sell signal: Generated when %K exceeds %D down and is above the 80% level.

4. Pros and cons of the Stochastic Oscillator

Pros:

Helps to identify turning points in the market.

Easy to interpret and apply.

Flexibility in adjusting time periods.

Cons:

Can generate false signals in strong trend conditions.

Requires confirmation by other technical indicators or price analysis.
 

Summary

The Stochastic Oscillator is a technical indicator that helps traders assess the overbought and oversold levels of the market, allowing them to identify potential turning points. Understanding the interpretation of signals generated by the Stochastic Oscillator can help traders make more informed investment decisions and better manage risk in financial markets.

 

Money Flow Index, or MFI

1. Definition and meaning in technical analysis

The Money Flow Index (MFI) is an oscillator that measures the strength of the money flow into and out of a financial instrument based on volume and price changes. The MFI is considered an oscillating indicator that helps identify overbought and oversold situations in the market.

2. Interpretation of the Money Stream Index in the context of price changes

The interpretation of MFI is based on two main areas:

Overbought and oversold levels: the MFI oscillates between values of 0 and 100.

Level 80: Signals that the market is overbought, which may suggest potential discounts.

Level 20: Signals that the market is oversold, which may suggest potential price increases.

 

3. Practical application: buy and sell signals

The MFI indicator generates buy and sell signals based on overbought and oversold levels, as well as mutual intersections of the average line:

Buy signal: Generated when the MFI falls below the level 20 and then returns above that level, signaling an increase in buying activity.

Sell signal: Generated when the MFI exceeds the level 80  and then falls below this level, signaling an increase in selling activity.

 

4. Pros and cons of the Money Stream Index

Pros:

Helps to identify extreme market levels.

Easy to interpret, especially for novice investors.

Works well in a volatile market liquidity environment.

Cons:

Susceptibility to false signals in a sideways trend.

Requires confirmation by other technical indicators or price analysis.
 

Summary

The Money Flow Index (MFI) is a useful tool in technical analysis, helping traders assess the strength of the cash flow in a particular financial instrument. Understanding how it works and how to interpret the signals allows for more informed investment decisions and more effective risk management in financial markets.

 

On-Balance Volume (OBV)

1. Definition and meaning in technical analysis

On-Balance Volume (OBV) is an oscillating indicator that measures changes in volume in a financial instrument relative to price changes. OBV is constructed by adding or subtracting trading volume depending on whether the closing price is higher or lower than the previous day.

2. Interpretation of On-Balance Volume in the context of price changes

The interpretation of OBV focuses on the direction and magnitude of volume change:

Rising OBV: Indicates that volume when prices rise is greater than when they fall, suggesting a strengthening of the upward trend.

Declining OBV: Indicates that volume when prices are falling is greater than when they are rising, suggesting a weakening of the upward trend.

3. Practical application: buy and sell signals

OBV generates buy and sell signals based on crossovers and changes in indicator direction:

Buy signal: When the OBV rises and confirms the price rise, it is a signal that reinforces the uptrend.

Sell signal: When the OBV falls and confirms the price decline, it is a signal that reinforces the downward trend.

 

4. Pros and cons of On-Balance Volume

Pros:

Helps to identify trend changes based on trading volume.

Easy to interpret, especially for novice traders.

Can confirm the strength or weakness of the current price trend.

Cons:

Susceptibility to false signals in a sideways trend.

Requires confirmation by other technical indicators or price analysis.
 

Summary

On-Balance Volume (OBV) is a useful tool in technical analysis, allowing traders to assess the strength of price trends based on trading volume. Understanding how it works and interpreting the signals allows for better risk management and more informed investment decisions in financial markets.

 

Average True Range (ATR)

1. Definition and meaning in technical analysis

Average True Range (ATR) is an indicator developed by J. Welles Wilder Jr. to measure the price volatility of a financial instrument. ATR does not give the direction of price changes, but it does provide information on the magnitude of price movements. It is calculated based on the difference between the maximum value of the following three prices: the maximum current value, the minimum value and the closing of the current quotation.

 

2. Interpretation of Average True Range in the context of price changes

ATR helps traders gauge how large typical price movements might be over a given period, which is important in determining stop-loss and profit levels. A high ATR means high price volatility, which can suggest higher risk, but also higher potential profits. A low ATR level means low volatility, which may suggest more stable market conditions.

3. Practical application: buy and sell signals

ATR is used in several contexts:

Setting stop-loss levels: Traders can use ATR to set stop-loss levels that are proportional to market volatility.

Selecting position size: A high ATR may suggest a smaller position size to minimize risk, while a low ATR may allow larger positions.

Confirmation of trends: Changes in ATR can confirm the strength of price trends, especially when ATR increases with a rising trend.

4. Pros and cons of the Average True Range

Pros:

It helps analyze price volatility, which is important for risk management.

Can be used over a variety of time frames, from short-term to long-term.

Easy to interpret and apply.

Cons:

Can generate false signals in sideways market conditions.

Requires understanding of market context and confirmation by other technical indicators.
 

Summary

Average True Range (ATR) is a key technical indicator that helps investors and traders analyze the price volatility of financial instruments. By using the ATR appropriately, traders can manage risk, set stop-loss and profit levels, and make more informed trading decisions in financial markets, including cryptocurrencies.

 

Parabolic SAR (Stop and Reverse)

1. Definition and meaning in technical analysis

Parabolic SAR, which stands for “Stop and Reverse,” was developed by J. Welles Wilder as an indicator that helps determine the direction of a market's trend and the points at which a reversal may occur. It is a tracking indicator that is indicated on the chart as a series of points that are above or below prices.

2. Interpretation of Parabolic SAR in the context of price changes

When Parabolic SAR points are under prices, this suggests an upward trend.

When Parabolic SAR points are above prices, this suggests a downward trend.

Parabolic SAR changes its position with prices, which means that SAR points can provide signals regarding a change in trend.

 

3. Practical application: buy and sell signals

Parabolic SAR provides several trading signals:

Buy signal: When Parabolic SAR points change their position from above prices to below, this can suggest a potential change from a downtrend to an uptrend.

Sell signal: When Parabolic SAR points change their position from below prices to above, this may suggest a potential change from an uptrend to a downtrend.

 

Parabolic SAR is particularly useful in dynamic market trends, where it can help traders identify entry and exit moments.

4. Pros and Cons of Parabolic SAR

Pros:

Easy to interpret, as it provides clear signals on trend changes.

Can be used in a variety of time frames, from short-term to long-term.

Helps manage risk by determining stop-loss levels.

Cons:

In a sideways market, it can generate false signals.

Without additional confirming indicators, it can be difficult to use on its own.
 

Summary

Parabolic SAR (Stop and Reverse) is a technical indicator that helps traders identify trends and turning points in financial markets, including cryptocurrencies. By tracking the position of Parabolic SAR points relative to prices, traders can make more informed trading decisions, manage risk and determine stop-loss and profit levels.

 

Chaikin Money Flow - CMF

1. Definition and meaning in technical analysis

The Chaikin Money Flow (CMF) indicator was developed by Marc Chaikin and is used to measure the strength of accumulation or distribution in the market. CMF measures the volume of money that enters and exits an asset, taking into account both the closing price and the volume of transactions.

2. Interpretation of CMF in the context of price changes

When the CMF indicator is positive, it means that the closing price is above the average price and the volume of transactions is high, indicating strong accumulation.

When the CMF indicator is negative, it means that the closing price is below the average price and the volume of transactions is high, indicating distribution.

 

3. Practical application: buy and sell signals

The CMF indicator provides several trading signals:

Buy signal: A rise in the CMF index above zero may indicate upward accumulation pressure, suggesting a potential change in the trend to upward.

Sell signal: A fall in the CMF index below zero may indicate downward distributional pressure, which may suggest a potential change in the trend to a downtrend.

 

The CMF indicator is particularly useful in conjunction with other technical indicators and price analysis to confirm trading signals and understand the market strength involved in a trend.

4. Pros and cons of CMF

Pros:

Helps identify accumulation and distribution in the market.

Easy to interpret as it shows the relationship between closing prices and trading volume.

Can be used in both stock and cryptocurrency markets.

Cons:

In a sideways market, it can generate false signals.

Without additional confirming indicators, it can be difficult to use on its own.
 

Summary

The Chaikin Money Flow (CMF) indicator is used in technical analysis to measure the strength of accumulation and distribution in the market, which helps traders identify trends and potential entry and exit points. By tracking changes in the CMF indicator, traders can make more informed trading decisions, taking into account the flow of money in the market.

 

Commodity Channel Index (CCI)

1. Definition and meaning in technical analysis

The Commodity Channel Index (CCI) was developed by Donald Lambert and is used to measure price volatility relative to their moving average. The CCI is typically used to identify trend reversals, price extremes and to identify moments when a price is too high or too low compared to its average.

2. Interpretation of the CCI in the context of price changes

CCI levels:

CCI above +100: Indicates strong upward momentum, which may suggest that assets are overbought.

CCI below -100: Indicates strong downward momentum, which may suggest that assets are oversold.

Trading signals:

Buy signal: When the CCI crosses above the -100 level upward, it may suggest a potential reversal of the uptrend.

Sell signal: When the CCI crosses the +100 level downward, this may suggest a potential reversal of the downtrend.

3. Practical application: buy and sell signals

The CCI indicator provides several useful trading signals:

Divergence: When the price rises and the CCI falls (or vice versa), this can indicate a change in trend.

Crosses: Crosses between -100 and +100 levels can be used to identify moments of market entry and exit.

 

The CCI indicator is also used to confirm trends and to identify periods of overvalued or overbought assets. It can be used alone or in combination with other technical indicators for better accuracy of trading signals.

4. Pros and Cons of CCI

Pros:

Helps identify price volatility and potential turning points.

Easy to interpret, especially in the context of +100 and -100 levels.

Can be applied to a variety of financial markets.

Cons:

In a sideways market, it can generate false signals.

Requires additional confirmations to avoid false trading signals.
 

Summary

The Commodity Channel Index (CCI) is used in technical analysis to measure price volatility and identify periods of overvalued or overbought assets. By tracking changes in the CCI, traders can make more informed trading decisions, taking into account price dynamics in the market.

 

Williams %R

1. Definition and meaning in technical analysis

The Williams %R indicator, developed by Larry Williams, is a momentum oscillator that measures the current closing price relative to the highest and lowest prices of a specific period. This indicator is used to identify periods of overbought and oversold financial instruments.

2. Interpretation of Williams %R in the context of price changes

Williams %R levels:

Williams %R above -20: The instrument is overbought, suggesting the possibility of a future downtrend reversal.

Williams %R below -80: The instrument is oversold, suggesting the possibility of a future uptrend reversal.

Trading signals:

Buy signal: When Williams %R falls below -80 and then returns above that level, it can be a signal to buy.

Sell signal: When Williams %R rises above -20 and then falls below that level, it can be a signal to sell.

3. Practical application: buy and sell signals

The Williams %R indicator provides some practical trading signals:

Divergence: When the price rises and Williams %R falls (or vice versa), this can indicate a change in trend.

Overbought and oversold: Helps identify periods when the price is too high (overbought) or too low (oversold).

 

4. Pros and cons of Williams %R

Pros:

Easy to interpret and quick to apply.

Helps identify potential market turning points.

Can be applied to both stock markets and other financial instruments.

Cons:

In a sideways market, it can generate false signals.

Requires confirmation by other technical indicators to avoid false trading signals.
 

Summary

The Williams %R indicator is a useful technical analysis tool for determining the overbought and oversold levels of financial instruments. By monitoring changes in Williams %R, traders can make more informed trading decisions, taking into account price dynamics in the market.

 

Rate of Change (ROC)

1. Definition and meaning in technical analysis

The Rate of Change (ROC) index measures the percentage change in price relative to the price before a certain period. It is a momentum oscillator that helps investors determine the rate at which the price of an asset changes over a specified time frame.

2. Interpretation of Rate of Change in the context of price changes

ROC calculation: it can be calculated for different time periods, from short-term to long-term. Shorter periods can generate more frequent trading signals, but may be more susceptible to market noise. Longer periods may give more stable signals, but may delay response to trend changes.

 

Trading signals:

Changes in the rate of increase and decrease: An ROC above zero indicates an increasing rate of price increases, while an ROC below zero indicates an increasing rate of price decreases.

ROC levels: Investors often watch for crossings of zero levels as signals of potential trend changes.

3. Practical application: buy and sell signals

The ROC indicator provides several practical trading signals:

Crossing zero: When the ROC crosses the zero level, it can signal a change in trend.

Divergence: When the price increases and the ROC decreases (or vice versa), this can indicate a possible trend reversal.

 

4. Pros and Cons of ROC

Pros:

Helps to identify the rate of price change.

Simple to calculate and easy to understand.

Can be applied to different time periods.

Cons:

In a sideways market, it can generate false signals.

Like most oscillators, it requires confirmation by other technical indicators
 

Summary

The Rate of Change (ROC) indicator is a useful technical analysis tool that helps traders assess rates of price change. By monitoring the ROC, traders can identify potential turning points in the market, allowing them to make more informed trading decisions.

 

ADX (Average Directional Index)

Definition and meaning in technical analysis

The ADX indicator is a tool used to assess the strength of a trend in the market. It was developed by J. Welles Wilder and is often used by traders to determine whether the market is in a trend, how strong the trend is, and whether the trend is beginning to lose strength or reverse.

ADX does not indicate the direction of the trend (whether the trend is up or down), but only assesses its strength. The ADX indicator is calculated based on the difference between two lines: the +DI (Directional Indicator Plus) and -DI (Directional Indicator Minus) lines.

ADX calculation

+DI (Directional Indicator Plus): Determines how much the price has risen in a given period.

-DI (Directional Indicator Minus): Determines how much the price has fallen during a given period.

DX (Directional Movement Index): The difference between +DI and -DI.

ADX is calculated as a moving average of the DX value over a specified number of periods. The most common number of periods is 14.

ADX Interpretation

ADX below 20: Weak trend or no trend. The market may be in a sideways (consolidation) state, and traders may expect the price to oscillate around a certain level.

ADX between 20 and 40: The trend is beginning to gain strength. An increase in the ADX value may suggest that the trend is becoming more established and more decisive in direction.

ADX above 40: Strong trend. The higher the ADX, the stronger the trend. Such values may suggest that the trend may already be well-formed and potentially continue.

Practical application of ADX

Trend identification: ADX helps traders determine whether the market is in a trend and how strong the trend is. It is especially useful in the middle of a trend, when traders can look for opportunities to join the trend.

Buy and sell signals: Strategies that use the ADX to generate buy and sell signals are often used. For example, when the ADX crosses above the 20 level, it can signal the potential start of a trend.

Confirmation of other indicators: ADX can be used to confirm signals generated by other technical indicators, such as oscillators or price patterns.

 

 

Pros and Cons of  ADX

Pros:

Helps to identify and measure the strength of the trend.

Relatively simple to interpret, especially for novice traders.

Can be effective in a variety of financial market timeframes.

Cons:

ADX does not indicate the direction of the trend, which can be a limitation for traders who are looking for more complete information.

In a sideways market, the ADX value can be low, which can lead to false or ineffective signals.

Summary

ADX is an important technical analysis tool that helps traders assess the strength of the trend in financial markets. Its uses include identifying trends, generating trading signals and confirming other technical indicators. It is crucial to understand that ADX does not indicate the direction of a trend, but only assesses its strength, which makes it a valuable tool in traders' arsenals.