Average Directional Index (ADX)

Average Directional Index (ADX) is a commonly used technical indicator to measure the strength of the current trend of the price action. Here we will cover the concepts and application of ADX and how it gets complimented by directional components to also know the direction of the trend.

Introduction

ADX stands for "Average Directional Index". ADX indicator was developed by J. Welles Wilder. ADX helps us in determining if the price action has a trend, either bullish or bearish, of the price action is running in a sideway range. ADX, alone, does not indicate the direction of the trend and just measures the strength of the trend. The indication of the direction comes by two associated components which are known as "Positive Directional Index" (+DI) and "Negative Directional Index" (-DI).

Please note that the explanation here is focused on Forex trading but the same is equally valid for stocks of any commodity trading.

Usage

Chart 1

ADX - example 1

The three crisscrossing lines below the price action chart in the above screenshot represent the ADX indicator. As indicated, one line is the main ADX line and other two are +DI and -DI lines.

ADX is an oscillator which moves between a range of 0 to 100 but it rarely goes above 60. If ADX is above 25, it indicates an underlying trend. Any value below 25 indicates the lack of a trend. A rising ADX represents the rising momentum of the trend and a drop in the value indicates that the momentum of the trend is slowing down.

Identification of Trend by ADX

ADX Trend Situation
Above 25 The market is trending
Above 25 and going up Trend is getting stronger
ADX Below 25 The market is running in range (ranging)

It is clear from the above table that ADX only indicates the trend strength but not the direction of the trend i.e. if the trend is bullish or bearish.

Trend Direction Recognition

As mentioned in the table above, the ADX only measures the strength of the trend without hinting about the direction of it. The direction identification is done by the +DI and -DI components.

Uptrend: An uptrend is indicated when ADX is above 25 and the +DI line stays over -DI line.

Downtrend: A downtrend is indicated when ADX is above 25 and the +DI line stays below -DI line.

ADX Crossover Signals

The crossover signals for market entry and exit are generated by the +DI and -DI lines' crossover.

1) +DI line moving upwards: When +DI line moves over -DI line, it indicates bullish sentiments and gives an signal for buying or exiting any short position which you might be holding.

2) +DI line moving downwards: When +DI line moves below -DI line, it indicates bearish sentiments and gives an signal for short-selling or to exit any already existing long position.

3) It is always better to consult ADX on longer time-frame charts say before taking a decision on shorter time-frame charts. Longer time-frame charts give us a broader picture of the longer term trend. In simple words the short term chart may indicate that the trend is weakening but a longer term chart may indicate that the drop is just a temporary correction and the trend still exists.

Chart 2

ADX - example 2

Formula and Calculation

Directional Indexes +DI and -DI

We do not need to memorize the following formulas and these are just for ready reference.

The +DI is the percentage of the true range that is up or the range of highs divided by the price range over the last period and previous close, smoothed over a given number of periods.

The -DI is the percentage of the true range that is down or the range of lows divided by the price range over the last day and previous close, smoothed over a given number of periods.

Step by step calculation

The Directional movement

  • If "Today's High"  >  "Yesterday's High" then +DM = (Today's High - Yesterday's High)
  • If "Today's Low" <  "Yesterday's Low" then -DM = (Yesterday's Low - Today's Low)
  • If +DM > -DM then: -DM = 0
  • If +DM < -DM then: +DM = 0

What is The True Range?

The true range is the largest of any of the following:

(Today's High - Today's Low)

(Today's High - Yesterday's Close)

(Yesterday's Close - Today's Low)

The next step is to calculate the moving average of +DM, -DM and the True Range

  • +DMMA = Exponential moving average of +DM
  • -DMMA = Exponential moving average of -DM
  • TRMA = Exponential moving average of the True Range

Now we calculate the positive and negative Directional Indicators i.e. +DI and -DI

  • +DI = +DMMA / TRMA
  • -DI = -DMMA / TRMA

The next step is to calculate the Directional Index

DX = [(+DI) - (-DI)] / [(+DI) + (-DI)]

What we are doing is dividing the numeric addition of the values of +DI and -DI disregarding the negative sign and dividing it with the difference of the same.

ADX Formula

The final step is to calculate the moving average of the calculated DX (directional index), as mentioned above, for a selected number of periods for which we wish to use ADX Hence the Average Directional Movement Index is calculated as follows

ADX = The exponential moving average of DX and hence the formula is as follows:

ADX = SUM[{(+DI)-(-DI)}/{(+DI)+(-DI)}, N]/N

Where:

N = The number of periods used in the calculation e.g. 14 period on a hourly chart means 14 hours and 14 period on a daily chart means 14 days.

ADX Divergences:

ADX trading signals are also generated or by divergences.

When the subsequent highs and lows (peaks and valleys) of ADX line are going lower than the previous highs and lows, It indicates for an existing or emerging down trend. Similarly if the subsequent highs and lows are going higher than the previous ones, it is an indication that an uptrend is in place or is emerging.

Period Settings for Average Directional Index

The common period setting for the ADX is 14 periods. On a daily chart 14 period translates into 14 days and on a 4-hourly chart it means previous 14 candles of 4-hours price action.

Check some thoughts about ADX and RSI Trading Strategies.
You may also check some more trading strategies using ADX with stochastic and Bollinger Bands.
Some more technical analysis strategies by using ADX with SAR, RSI and MACD.

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