Crypto Academy / Season 3 / Week 7 - Homework Post for @kouba01 - Trading Crypto With Average Directional Index (ADX) Indicator

Good day everyone. Thanks to @kouba01 for such a wonderful lecture on Trading Crypto With Average Directional Index (ADX) Indicator. I will be doing the homework from the lecture, so sit back and look for somewhere quite quiet and comfortable as you read through this amazing article I created just for you(😉). Let's get started!!!

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Question 1: Discuss your understanding of the ADX indicator and how it is calculated? Give an example of a calculation.

From my understanding of ADX indicator also known as Average Directional Index, it is not a stand alone indicator which helps determine price movement for traders, rather it is a supporting indicator that helps to measure the strength of a trend.

To fully utilize the ADX indicator for trading purposes, you need to add some other good indicators such as Pivot Points and Ichimoku indicator. The reason for this, is that, ADX indicator is a slow indicator, it gets to detect signals a bit late, but that doesn't take away the fact that it is a very good indicator which can be used to know the strength of a trend, which is quite very good for scalp traders, as they will keep making profits, since they know the trend is strong or very strong.

Take a look at the XRP/USDT chart below to know how an ADX indicator looks like.

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I hope you can clearly see how ADX indicator looks like. But how can we measure the strength of a trend from that(the chart above).

Quite simple, the ADX indicator has ADX values from 0 to 100. Where ever the ADX line is, indicates the strength of the trend.

From the chart above, we can clearly see that ADX indicator is currently at 30, which indicates a strong bearish trend. Take a look at the image below for more understanding.

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Okay, you can now clearly see how the ADX indicator line and value works. But how do we know that a trend is strong or weak? It is quite simple, ADX indicator has different range values which indicates the strength of a trend.

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• When ADX indicator is between 0 to 25, it indicates No Trend or Very Weak Trend.

• When ADX indicator is between 25 to 50, it indicates Strong Trend.

• When ADX indicator is between 50 to 75, it indicates Very Strong.

• When ADX indicator is between 75 to 100, it indicates Extremely Strong Trend.

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ADX is a component of Directional Movement System also known as Directional Movement Index (DMI). The DMI helps traders to determine the direction of the trend and when added to the ADX, it creates a clearer understanding of the chart's trend direction for a trader, as the trader will be able to get signal of which direction the trend is going using the DMI and crosscheck it with ADX, to measure the strength of the trend, which will lead to better decision making by traders.

The DMI comprises of two lines which are DI+ and DI- lines. This lines signals traders when there is a rise and fall in price, although, as a trader, you shouldn't strongly rely on this lines very well, as they often create false signals which may result to loss of funds for traders.

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• DI+ indicates uptrend, thus, whenever DI+ is above DI-, it indicates an uptrend price movement.

• DI- indicates downtrend, thus, whenever DI- is above DI+, it indicates a downtrend price movement.

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Take a look at the chart below for more understanding.

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From the image above, the Blue Line is DI+ while the Green Line is DI-. As you can clearly see from the chart, when DI- was above DI+, the price was falling i.e downtrend price movement. And when DI+ was above DI-, the price was rising i.e uptrend price movement. I hope you now understand ADX and DMI indicators better now.

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ADX Calculation

Below are the steps you take in calculating ADX;

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• Step 1: You have to calculate DMI+ and DMI-.

DMI+ = Current Day High - Previous Day High

DMI- = Previous Day Low - Current Day Low

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• Step 2: Calculate True Range

True Range (TR) = Max[(High – Low), (High – Previous Close), (Previous Close – Low)]

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• Step 3: Calculate both the positive and negative Directional Indexes

+DI = ( +DM / TR ) * 100
 
-DI = ( -DM / TR ) * 100

• Step 4: Calculate Directional Difference and Sum

DIdiff = ((+DI) - (-DI)) 

DIsum = ((+DI) + (-DI))

• Step 5: Calculate Direction Movement Index (DX)

DX = ( DIdiff / DIsum ) * 100

• Final Step: Calculate ADX

ADX = Sum of n (DX)/ n

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Illustration

Current High = 50
Previous High = 40
Current Low = 45
Previous Low = 40
Previous Close = 43
Number of Periods = 15

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• Step 1

DMI+ = 50 - 40
= 10

DMI- = 40 - 45 
= -5

:- DMI+ = 10 and DMI- = -5

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• Step 2

TR = (50 - 45), (50 - 43), (43 - 45)

TR = 5, 7, -2

The True Range is 7

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• Step 3

+DI = 10/7 * 100

= 142.87 = 143.

-DI = -5/7 *100

= 71.42 = -71

:- +DI = 143 and -DI = -71

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• Step 4

DIdiff = ((143) - (-71)) 
= (143) + (71)
= 214

DIsum = ((143) + (-71))
DIsum = 143 - 71
= 72

:- DIdiff = 214 and DIsum = 72

• Step 5

DX = (214/72) * 100
DX = 2.97 *100
= 297

• Final Step

ADX = (297)/15

ADX = 19.8 = 20

ADX is 20, hence, no Trend, as it falls between 0 - 25

Question 2: How to add ADX, DI+ and DI- indicators to the chart, what are its best settings? And why?

I make use of Huobi Exchange Platform when trading, as I like the set up of the charts and it has so many indicators and I'm quite used to the platform. I will show you how to add ADX, DI+ and DI- indicators to your chart on Huobi Exchange Platform.

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As soon as you are on the main page of Huobi Exchange, click on Spot Trading which can be found at the headers section. When you click it, you will see a dropdown, click on Exchange. Look at the image below for more understanding.

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That will lead to exchange section of the platform. Now you can see where you can be able to choose your preferred coins pairing, the chart and others. To view your chart better, click on Full Screen. Look at the image below for more understanding.

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Congrats, you are now looking at your chart on Full Screen. Now you should add ADX, DI+ and DI- indicators to your chart. You will have to click Index, which can be found at the top sections of the page. Look at the image below for more understanding.

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When you click on it, you can then search for ADX, DI+ and DI- indicators. They two indicators ADX indicators, there is an ADX indicator which display only ADX line while Directional Movement indicator which display ADX line, DI+ and DI- indicators, all at once. So, I will suggest you search for DM or Directional Movement, at the search bar of Indicators and then click on it.

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Boom!!! You can now see your ADX, DI+ and DI- indicators on your chart.

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You can modify the indicators to suit your preference and also know and choose which color you want as your ADX Line, DI+ and DI- Line, just by clicking on the indicator setting, which is known as Format on Huobi Exchange. Look at the image below for more understanding.

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Here is how the Style setting for DM indicator looks like(image below). You can see color, for ADX, DI+ and DI- indicator. You can also increase the intensity of the color you view your indicators better.

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I changed my colors to suit my preference and increased the color intensity, to view my indicators better. Take a look at the change.

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For the input setting, you have your DI Length and ADX Smoothing at 14, default setting. What this default setting means, is that, the ADX Smoothing will take readings from the last 14 candlesticks in order to provide traders some signals.

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Best ADX Indicator Setting And Why?

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Different setting for different kind of traders. Scalp traders and Swing traders will definitely be using different ADX indicator setting as their type and strategy for trading are different, hence, different ADX indicator setting.

For scalp traders, they will make use of shorter period for ADX Smoothing and DI length. The advantage for this type of setting, is that, you will be able to see more signals. Although, the disadvantage of this setting, is that most of the signals will be false. Let me use 7 periods to see the effect it will have.

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As you can see from the chart above, so many crosses and signals for traders.

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For Swing traders, they will make use of longer period for ADX Smoothing and DI length. The advantage of this type of setting, is that, there are less false signals. Although, the disadvantage of this setting, is that, signals may come too late for traders. Let me use 25 periods to see the effect it will have.

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As you can see from the chart above, there are very fewer crosses and less volatility with the indicator, hence, less false signals.

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My best setting may not work for you and your best setting might not work for me, hence, different settings for different traders. You need to study which setting works best for your trading strategy and make use of it. For me, I will be using the shorter period because I'm scalp trader. I will use the Ichimoku indicator to confirm my signals before entering the market.

Question 3: Do you need to add DI+ and DI- indicators to be able to trade with ADX? How can we take advantage of this indicator?

We can make use of only ADX indicator to trade because we can determine the strength of a trend using this amazing indicator. It is not a must that we have to add DI+ and DI- indicators before we can trade with ADX, we can even use other indicators with ADX indicator to trade even better. ADX and DI+ and DI- indicators, works well together, but they can be used independently. DI+ and DI- indicators just makes ADX indicator clearer for traders to understand.

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How can we take advantage of this indicator?

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We can use this indicator to how advantage, in two ways, which are;

• Determination of Trend Strength

• Determination of a Bullish or Bearish Trend.

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• Determination of Trend Strength: The ADX Line is a very useful tool, as it helps to indicate the strength of the trend and it does not care if it is bearish or bullish trend. So, if you study the ADX Line very well, you will notice that whenever it is beyond 25 value, it is a strong trend whether it is bearish or bullish. Traders mistake the ADX Line when it goes up, and think it is Bullish indication. That's wrong because it could be bearish market, but it is just indicating that the bearish market trend is quite strong. Look at this image below for more understanding.

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As you can see from the chart above, the price is falling and the ADX Line is rising and going higher, indicating that it will be strong bearish market. Traders can use that signal to their advantage, by entering Sell Entry when they notice a continuous rise in the ADX Line.

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• Determination of Bullish or Bearish Trend: We can add the DI+ and DI- to determine if the market will be bearish or bullish market. Whenever DI+ is above DI-, the market is bullish. If the ADX line is rising while DI+ is above DI-, that's a good signal to buy. Also, if DI+ is below DI-, the market is bearish. If the ADX line is rising while DI+ is below DI-, that's a good signal to sell. Let's take a look at an example below.

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You can see from the chart, that when DI+ was above DI- and the ADX line was rising, it was a clear bullish market trend, and a signal for traders to buy. Also, if ADX line is falling, it doesn't indicate a change in trend, it just means, that trend isn't strong and it is consolidating.

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I hope by now, you know how to make use of this indicator to your advantage.

Question 4: What are the different trends detected using the ADX? And how do you filter out the false signals

There are mainly 4 different trends which can be detected by using the ADX indicator. Different trends are mainly determined by the ADX value which ranges between 0 - 100. Below are the 4 different trends, which are;

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• No Trend or Weak Trend
• Strong Trend
• Very Strong Trend
• Extremely Strong Trend

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• No Trend Or Weak Trend: This trend is detected when the ADX line is between 0 - 25. When the ADX Line is between this range, there's usually no trend or a weak trend, as the price is consolidating. Traders should relax and wait out this trend. Below is an example of a No Trend or Weak Trend.

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• Strong Trend: This trend is detected when the ADX line is between 25 - 50. This is the most common trend detected by traders. This indicates that market is having strong trend and traders, should be ready to place their Buy or Sell trade. Below is an example of a Strong Trend.

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• Very Strong Trend This trend is detected when the ADX line is between 50 - 75. It is not a common trend detected by traders. This indicates a very strong bullish or bearish market trend. If you see this kind trend, place in your buy or sell immediately. Below is an example of a Very Strong Trend.

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• Extremely Strong Trend: This trend is detected when the ADX line is between 75 - 100. This is rarest trend, very hard to come by. This trend indicates a major break out from either a support or resistance. You place a huge fund on your trade when you see this kind of trend, because it is rare and very uncommon, so, it is usually a solid signal for traders to place a huge Buy or Sell trades. Below is an example of an Extremely Strong Trend.

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How do you filter out the false signals?

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After using the ADX indicator for over 3 days, I can confidently say the best way to filter false signals is by confirming your DI+ and DI- indicators with your ADX indicator.

Changing your DI length and ADX Smoothing for longer period, is not a solution, as you will miss out on so many good signals. As it may be too late before you see the signal.

But whenever you confirm your DI+ and DI- indicators with your ADX indicator, you can easily filter false signals, and get really good signals. If you DI+ and DI- indicator is pointing towards a bullish trend or bearish, use your ADX to confirm if such trend is strong before entering into your trade.

Ensure that your ADX Line is above 45 ADX value before you use the trend signal of DI+ and DI- indicator to enter a trade. By waiting for a high ADX value, you are easily filtering false signals. I feel this is the best approach to filtering false signals when using the ADX indicator.

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Question 5: Explain what a breakout is. And How do you use the ADX filter to determine a valid breakout?

Breakout occurs when the resistance or support of an asset has been broken. Breakout occurs when traders are overbuying or overselling an asset because of the Fear Of Missing Out (FOMO). When price breaks out, if it is a resistance breakout, traders will want to buy more of the assets, so as to make more profits and won't want to miss out on the opportunity. And if it is support breakout, traders will be selling their holdings of an assets, as not to incur losses from the assets, hence, the price continues to fall.

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The image above is the $20,000 BTC breakout. The $20,000 breakout is very significant in the world of cryptocurrency. After the break, it continued to increase and increase. That's a good example of breakout.

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How do you use the ADX filter to determine a valid breakout?

Using my very own ADX filter, I use when filtering false signals, it becomes quite easy to determine a valid breakout. To determine a valid breakout, you have to detect whenever your ADX line is above 45 ADX value and there is breakout either support breakout or resistance breakout. That will be a valid breakout because after the breakout your ADX Line is above 45 ADX value and rising. And that's how you determine a valid breakout using my very own ADX filter. Take a look at the image below for more understanding.

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Question 6: What is the difference between using the ADX indicator for scalping and for swing trading? What do you prefer between them? And why?

Before I state the difference between using the ADX indicator for scalp trading and swing trading, let me first explain what scalp trading and swing trading means, so you know the reason for the difference when using ADX indicator.

Scalp trading involves the trader making a lot trades in a day and scalp traders are almost always glued to the market, as every bit of information they get, they make use in trading. Whereas Swing trading involves the trader placing a trade for days and sometimes weeks. Swing traders, are hardly glued to the market, once they make their market prediction and place their trade, they wait patiently for trade.

You can clearly see that these two traders have two different strategy. So, when using the ADX indicator, these two different traders will definitely use the ADX indicator differently.

A scalp trader will make use of a shorter period when using the ADX indicator, because a scalp trader, needs signals a lot and shorter period provides a lot of signals, which will be very useful to scalp trader.

On the other hand, a swing trader will make use of a longer period when using the ADX indicator, because a swing trader, doesn't reply on a lot of signals, he/she only relies on a very good signal, which he/she can benefit from when using a longer period.

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As for me, I prefer scalp trading, because I'm not so patient. I can't place a trade and wait several days, it is almost impossible for me. I like to know if my day was profitable or not. And since I understand how to filter false signals, scalping trading when using ADX indicator, just got super simple for me, as I will perfectly wait for the right set up before I place my trade. And my set up for buy signals, is that the ADX line must be around 40 - 50 and rising and the DI+ must be above DI-. I can patiently wait for this set up all day and once I see it, I place my trade and make some good profit for the day. Many people may choose Swing trading, because they are worried about the many false signals associated with Scalp trading. They choose Swing trading because they don't know how to filter false signals, but I can adequately filter false signals and that's why scalp trading is my choice.

Conclusion

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The ADX indicator, is an amazing indicator, one of the best indicator I have come across. Knowing how to filter false signals and knowing the perfect buy set up, might ensure a scalp trader making good profits on a daily basis.

This is a super assignment, as I get to understand ADX indicator, DI+ and DI- indicators. I understood how to calculate ADX as well as know how to use this amazing indicator to my advantage. And finally I learned how to filter false signals which is the most important aspect of the ADX indicator, as that will ensure that, I can start using it in real life and making good profits.

Special thanks to you, @kouba01 , for organizing this amazing class and giving this nice assignment, as it has helped me in understanding ADX indicator.