Average Directional Index (ADX)
By Marcus Fei

 

What is it?

 

Developed by J. Welles Wilder Jr., ADX was published in his 1978 classic “New Concepts in Technical Trading Systems” together with a number of other popular technical indicators such as the RSI.

 

ADX is derived from another study that is known as the Directional Movement (DMI). The DMI study consists of two lines that are known as the Positive Directional Index (+DI) and the Negative Directional Index (-DI). +DI essentially measures the upward (positive) movement and the –DI measures the downward (negative movement). In its simplest form, a buy signal is given with +DI crosses above –DI and a sell signal is given when –DI crosses above +DI. As with other technical systems, DMI is prone to produce many false signals during a trading range and should be used in conjunction with other technical indicators.

 

ADX is essentially the smoothed average of the difference between the +DI and –DI. At TradeSignum.com, when ADX is selected, +DI/-DI is always plotted together. The default smoothing period is set at 14 periods and you are encouraged to adjust it to suit your analysis. ADX is an oscillator that fluctuates between the values of 0 to 100.

 

What is it used for?


ADX is used to assess if the market is trending and if so, at what strength? ADX is not used to gauge the direction of a trend. It is only used to assess the strength of a trend.

 

How to use it?

 

Generally a reading below 20 indicates a weak trend and a reading above 40 indicates a strong trend. A rising ADX indicates a trend is strengthening while a declining ADX indicates a trend is weakening.

 

A downturn from above 40 that moves below 40 is used to signal a possible end of a trend, a correction or the onset of a trading range. An upturn from below 20 that rises above 20 is used to signal the start of a new trend or the resumption of the trending phase.

 

 

The BJTOTO example above is used to illustrate that ADX is used as a measure of strength irrespective of the direction of the trend. As can be seen, ADX started turning up below 20 and began its ascend while BJTOTO started a major bear move.

As you can see in the above two examples, when ADX rises above 20, it signals a beginning of a trend and this trend can be either a bull move or a bear move. The direction of the trend will be very apparent if you then consider the crossing of the green (+DI) and red (-DI) lines.

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