ADX and ATR: How to Use These Indicators Like a Pro

Trend trading is a popular technical strategy among institutional and retail traders alike, and is particularly favored by many individual traders. If you’re already familiar with software like NinjaTrader, you probably already use some type of trend trading.

This can be a highly successful technical strategy if you’re able to use indicators like ADX and ATR for advanced trend analysis. Here’s how you might incorporate them into your trading.

Advanced Trend Analysis for More Informed Trades

Successfully using a trend strategy requires going beyond simply identification of trends, and being able to conduct true analysis of the trends that you identify.

Merely recognizing trends can leave you a little-informed trader, and little-informed traders often have little-funded portfolios. Holding beyond when a trend ends can bring losses, and selling before a trend is over can result in fewer gains. The combination of some losses and smaller wins makes it difficult to sustain long-term growth of your portfolio.

ADX and ADR provide more advanced information about trends, so you can make more informed — and hopefully better — trading decisions.

What is ADX?

The Average Directional Index (ADX) indicates trend strength. The indicator doesn’t show whether there’s an uptrend or downtrend, but rather how strong the trend upwards or downwards currently is. A strong trend could be expected to continue, while a weak trend might soon peter out.

ADX is given as a number between 0  and 100, although you’ll rarely see any high numbers. Even very strong trends are frequently between 40 and 60. For a general breakdown of ADX readings:

• 0 – 10: Nonexistent trend
• 10-20: Weak trend
• 20-40: Moderate trend
• 40-50: Strong trend
• 50+: Very strong trend

In addition to looking at individual readings, you can glean even more information by comparing readings. A rising ADX shows a trend that’s getting stronger, while a falling ADX shows that the trend is waning.

What is ATR?

The Average True Range (ATR) indicates volatility over a specific period. Traders use to gauge ranges, and when there’s a price break outside of the expected range that could indicate a new short-term move or trend.

Like ADX, ATR is independent of price direction. It simply looks at how much the price has been changing.

The True Range (TR) for any given moment is based on three subtraction calculations:

• Current high – current low
• Current high – previous close
• Current low – previous close

ATR is a moving average that’s arrived at by averaging each TR over a given period. The most common interval for ATR is 14 days, thus averaging the TR of the past two weeks. You could use a different interval for ATR if another period better suits your trading style, though.

These calculations can vary substantially, with ATR being 2, 6, 40 or almost anything else. The more an equity or derivative has been moving recently, whether within a band or breakout, the higher the ATR will be.

Using ADX and ATR Together

Knowing trend strength or volatility independent of each other is helpful, but these indicators become especially useful when combined. There are several ways to use ADX and ATR together. (These can be used for long or short positions, as the indicators are independent of price direction.)

Confirm Breakout Trends

Breakout traders may use these indicators to confirm breakouts that they want to take positions on.

See the setup for a breakout? Check whether ADX is above 20 (preferably well above) and ATR is rising. This would indicate a strong trend, and increasing volatility because of the new trend.

You might also use ATR to determine when a breakout has actually started. ADX could indicate a potential trend that’s forming within the recent price range. ATR could then show when the trend actually breaks from the recent range.

Of course, these can also be used to further confirm candlestick setups or other breakout indicators.

Example of Breakout Confirmation

Candlestick formation shows price action breaking above resistance. This is paired with an ADX of 30 and a spiking ATR. This is a setup for going long.

Stop Losses and Profit Taking

Every trader needs to protect themselves from downside, and each of these indicators can again help.

ADX is generally helpful with scaling trades. Cut losses or take profits more if ADX is falling, or consider letting more run if ADX is remaining strong.

ATR provides more specific points to set your stop losses and take profits. Quantifying volatility helps you determine how much of a potential dip you’re willing to sustain.

Example of Stop-Loss Adjustment

A common stop loss to start with is 1 – 2x ATR, but you may adjust this as ADX begins to drop.

Consider a breakout that has an ATR of 6 and an ADX of 30. The calculation would suggest an initial sell at 12 points from the breakout (1 – 2x 6 ATR = 12), and your standard strategy suggests selling half at this point. ADX remains at 30, which is still fairly strong, when price action reaches 12 points, however.

You might only sell ⅓ at this point and let more ride, because of the strong ADX. Conversely, you may fully exit if ADX has fallen to 20 once price action reaches 12 points from the breakout price.

Avoid False Signals

On their own, either ADX or ATR could suggest a false move. A strong ADX means a growing trend, but that trend might not last long if it’s still range-bound. Price action outside of the recent range would cause ATR to spike, but the spike might not last long if ADX is too low. The double confirmation can help you avoid taking positions on these setups.

Example of False Signal

ATR spikes suddenly, but ADX is below 20. You’d probably take no action.

ADX is 40 but ATR hasn’t substantially changed. This is a wait-and-see.

Understanding Order Flow

You can further leverage ADX and ATR by using them alongside Order Flow Analysis. Order flow shows you buying and selling, and how much is being traded. Knowing strength and volatility through ADX and ATR gives you context for understanding the trading volume. Integrating these together is simple with the Impact Order Flow Indicator.

Using ADX and ATR in NinjaTrader

Integrating ADX and ATR into your trading strategy is each on NinjaTrader. Here are a few ways to set up the indicators:

• Plot on separate panels to more easily see each indicator, and compare them yourself.
• Set up alerts for when ADX crosses key thresholds (e.g. 20 and 40).
• Set up alerts for when ATR spikes beyond its recent moving average.
• Use NinjaTrader’s Strategy Builder to automate some moves (but still monitor them).

For help setting up alerts, our NinjaTrader Signals Package makes it easy to integrate ADX and ATR alerts for your watch list.

Set Up ADX and ATR

At Affordable Indicators, we’re proud to offer the Best ADX Indicator and Best ATR Indicator. There’s not a simpler way to integrate these two indicators into your trading on NInjaTrader. Doing so will give you much more information on the breakouts you consider playing.