Table of Contents
- What Is the Average Directional Index (ADX)?
- Key Takeaways
- Average Directional Index (ADX) Formula
- Calculating the ADX
- What Does the ADX Tell You?
- The Average Directional Index vs. The Aroon Indicator
- Limitations of Using the ADX
- What Is a Good Average Directional Index?
- Is ADX a Good Indicator?
- What Is the Best Indicator to Use With ADX?
- The Bottom Line
What Is the Average Directional Index (ADX)?
Let me explain the average directional index (ADX) to you—it's a technical analysis indicator that some traders use to figure out how strong a trend is.
The trend could be going up or down, and you see this through two other indicators: the negative directional indicator (-DI) and the positive directional indicator (+DI). That's why the ADX usually shows up with three separate lines. You can use these to decide if you should go long or short on a trade, or maybe skip it altogether.
Key Takeaways
Welles Wilder designed the ADX for daily commodity charts, but now technical traders apply it across various markets to evaluate trend strength. It incorporates a positive (+DI) and negative (-DI) directional indicator along with the main trendline.
When the ADX is above 25, the trend has strength; if it's below 20, the trend is weak or the price is trendless, as per Wilder. Remember, non-trending doesn't mean the price is stuck—it might be changing trends or just too volatile for a clear direction.
Average Directional Index (ADX) Formula
The ADX involves a series of calculations because of its multiple lines. Here's the breakdown: +DI equals (Smoothed +DM / ATR) times 100, -DI equals (Smoothed -DM / ATR) times 100, DX equals the absolute value of (+DI minus -DI) divided by the absolute value of (+DI plus -DI) times 100, and ADX equals (Prior ADX times 13 plus Current ADX) divided by 14.
In these formulas, +DM is Current High minus Previous High, -DM is Previous Low minus Current Low, Smoothed +/-DM is the sum from t=1 to 14 of DM minus (sum from t=1 to 14 of DM divided by 14) plus Current DM, and ATR is the Average True Range.
Calculating the ADX
You start by calculating +DM, -DM, and the true range (TR) for each period—typically 14 periods. +DM is current high minus previous high, -DM is previous low minus current low. Use +DM when current high minus previous high is greater than previous low minus current low, and -DM in the opposite case.
TR is the greatest of current high minus current low, absolute value of current high minus previous close, or absolute value of current low minus previous close. Then smooth the 14-period averages of +DM, -DM, and TR. For ATR, the previous ATR is the sum of 14 TR values divided by 14, and current ATR is previous ATR times 13 plus current TR, divided by 14.
Divide smoothed +DM by smoothed TR to get +DI, multiply by 100. Do the same for -DI. The directional movement index (DMI) is +DI minus -DI divided by their sum (absolute values), times 100. To get ADX, calculate DX for at least 14 periods, then smooth: first ADX is sum of 14 DX divided by 14, and after that, ADX is (prior ADX times 13 plus current DX) divided by 14.
What Does the ADX Tell You?
The ADX, along with -DI and +DI, acts as momentum indicators. It helps you determine trend strength, while -DI and +DI show the direction.
An ADX over 25 means a strong trend, and below 20 means a weak one. You can use crossovers of -DI and +DI for trade signals—for instance, if +DI crosses above -DI and ADX is above 20 or ideally 25, that's a potential buy. If -DI crosses above +DI with ADX above 20, consider a short trade.
These crosses also work for exiting trades: if you're long, exit when -DI crosses above +DI. When ADX is below 20, it signals a trendless price, so it might not be the best time to enter a trade.
The Average Directional Index vs. The Aroon Indicator
The ADX has three lines, while the Aroon indicator has two. Both have lines for positive and negative movement to identify trend direction, and both help gauge trend strength. But their calculations differ, so crossovers happen at different times.
Limitations of Using the ADX
Crossovers happen often, sometimes too often, leading to confusion and potential losses on trades that reverse quickly—these are false signals, more common when ADX is below 25. Even when ADX goes above 25, it might dip back down and reverse with the price.
Like any indicator, combine the ADX with price analysis and possibly other indicators to filter signals and manage risk.
What Is a Good Average Directional Index?
An ADX above 25 is considered strong. Below 20, the trend is weak or the price is trendless.
Is ADX a Good Indicator?
Yes, but it gives better signals when you combine it with price analysis. Use ADX first to check if prices are trending or not, then pick your trading strategy accordingly.
What Is the Best Indicator to Use With ADX?
The ADX pairs well with other technical indicators like the relative strength index (RSI). ADX measures trend intensity, while RSI adds a time-based element for better entries and exits.
The Bottom Line
Technical traders use the average directional movement index (ADX) to assess trend strength and direction. With it, you can tell if a market is trending or ranging and apply the right strategy. This approach can be profitable with low risk, which is why traders like it. Similar indicators include the parabolic SAR, moving averages, and envelopes.
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