Average Directional Index (ADX)

The Average Directional Index (ADX) is a technical indicator designed to assess the overall strength of a trend. Created by J. Welles Wilder, the ADX assists traders in evaluating the intensity of price movements and whether the momentum is increasing or decreasing.

It is crucial to note that while the ADX gauges the strength of a trend, it does NOT indicate the direction of that trend. It can help determine if the market is in a range or initiating a new trend.

The oscillator operates on a scale from 0 to 100, with higher values signifying a strong trend and lower values indicating a weak trend. The ADX is associated with the Directional Movement Index (DMI), which includes the ADX line as part of its calculations.

The ADX employs a unique method for trend analysis. It does not specify whether the price is trending upward or downward, but it does indicate if the price is trending or ranging. This characteristic makes it a valuable tool for filtering either range or trend strategies, ensuring that trades align with current market conditions.

The ADX ranges from 0 to 100. Wilder suggested that a value above 25 indicates a trending market, while a value below 20 suggests minimal or no trend. A reading of 0 implies that the price is equally likely to move in either direction, indicating a lack of overall market trend. Conversely, a value of 100 signifies that the price is moving exclusively in one direction, indicating an extremely strong trend.

Here are some guidelines:

• If the ADX value is between 0-20: The trend strength is considered absent or weak.
• If the ADX value is between 25-50: The trend strength is regarded as strong.
• If the ADX value is between 50-75: The trend strength is very strong.
• If the ADX value is between 75-100: The trend strength is exceptionally strong.

Values exceeding 60 are uncommon. Any reading below 20 is seen as a weak trend and may indicate a potential reversal. If the ADX declines from high values, it may suggest that the trend is concluding, prompting consideration of closing any open positions.

A declining ADX indicates that price movement may be becoming less directional, suggesting a weakening trend. Caution is advised when using trend-following systems in this scenario. If the ADX has remained below 20 for an extended period and then begins to rise, it may signal an opportunity to trade the current trend. An increasing ADX indicates that the price is exhibiting a strengthening trend.

The value of the ADX correlates with the slope of the trend. If the price trend maintains a constant slope, the ADX value tends to stabilize. Remember, since the ADX is derived from both positive and negative directional indicators, it solely measures TREND STRENGTH rather than TREND DIRECTION.

The ADX is calculated from two directional indicators, known as DI+ and DI-:

• The positive directional indicator (+DI)
• The negative directional indicator (-DI)

These indicators are derived from the Directional Movement Index (DMI). The ADX is computed by finding the difference between DI+ and DI-, as well as the sum of DI+ and DI-. The difference is divided by the sum, and the resulting figure is multiplied by 100. This outcome is referred to as the Directional Index or DX.

A moving average is then applied to DX, typically over a fourteen-day period (though any number of periods can be utilized). This final moving average represents the ADX.