The ADX Indicator: How to Profit from Strong Trends

The ADX indicator is a non-directional indicator. Thus, it measures the intensity of the trend, whether bullish or bearish, but does not tell us its direction.

The indicator was developed by Welles Wilder and is usually used by plotting two lines known as DMI (Directional Movement Indicators or directional indicators). One is the +DI line (positive directional index or positive direction line) and the other is the -DI line (negative directional index or negative direction line). We will explain its calculation later.

The ADX indicator

The Average Directional Index (ADX) is a tool of technical analysis, that is, one that uses visual resources and indicators to anticipate trends of values or financial assets.

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Calculation of the ADX indicator

To start, we must calculate these two lines that we mentioned previously:

  • +DM: It is the positive directional movement. It reflects the bullish sentiment. It is calculated as follows: If (today's maximum-yesterday's maximum) > (yesterday's minimum-today's minimum) then +DM is equal to today's maximum-yesterday's maximum. Otherwise, the value is zero.
  • -DM: It reflects the bearish sentiment. It is calculated with the following rule: If (yesterday's minimum-today's minimum) > (today's maximum-yesterday's maximum) -DM takes the result of the subtraction: (yesterday's minimum-today's minimum). Otherwise, -DM is zero.

Then, we will calculate the True Range (TR), which, in turn, is the greatest, in absolute terms, between the following three alternatives:

  • Today's maximum minus today's minimum
  • Today's maximum minus yesterday's close.
  • Today's minimum minus yesterday's close.

Subsequently, what is done is to smooth the results obtained by taking a quantity of data (Wilder established it at 14). Specifically, an exponential moving average is calculated.

The first smoothed TR (TR14) is the simple average of the first 14 TRs. The following would be: (13/14)*(TR14 of the previous period)+(TR of today)/14

The same is done with +DM and -DM. Then, the +DI and -DI directional indicators are calculated.

+DI14=+DM14/TR14

-DI14=-DM14/TR14

As the next step, we will calculate the directional index (DX) which is the difference between the directional indicators between the sum of the same. In addition, the absolute value of all the results is obtained.

DX = ABS[(+DI14 minus -DI14) / (+DI14 plus -DI14)]

Finally, the first ADX is calculated as the simple average of the first 14 values of DX, and then:

ADX14=(13/14)*(ADX14 of the previous period) + DX of today/14

The calculation is somewhat complex, but it is necessary to know that we are working with a kind of moving average that takes 14 values.

ADX: What is it for?

ADX measures the strength of the current trend. It is a normalized oscillator, that is, it always moves within the same scale which in this case is between 0 and 100. The steeper the positive slope of the ADX, the greater the strength of the trend. A negative slope indicates that there is no trend, or that the previous trend is losing.

How is ADX used?

ADX is used with the following interpretation:

  • An ADX value below 20 indicates a market without trend and low volatility.
  • A value above 20 marks the beginning of a trend (it can be both bearish and bullish).
  • If the ADX has a value above 40 and begins to decline, it is a sign of weakness in the current trend.
  • If the ADX is above 60, it indicates that the trend is close to exhaustion.

The ADX does not report the direction of the trend, its use is to determine only if the market is in trend or not and evaluate its strength. Its usefulness lies in supporting more decisions in indicators or oscillators that behave better according to the type of market we are in.

Meanwhile, the DMI lines are used by observing the cuts between them. If the +DI line crosses upwards the -DI line, a purchase is activated because an uptrend is expected. On the other hand, if -DI crosses upwards to +DI, a sale is activated because a downtrend is expected.

Trading Suggestion with ADX:

The two indicators can be used simultaneously. The ADX is used to filter the signals provided by the DMI:

  • Buy or Open Long Position: (+DI crosses upwards to -DI) + (ADX increasing above 20.)
  • Sell or Close Long Position: (+DI crosses downwards to -DI) or (ADX decreases.)
  • Sell on Credit or Open Short Position: (-DI crosses upwards to +DI) + (ADX increasing above 20.)
  • Buy or Close Short Position: (-DI crosses downwards to +DI) or (ADX decreases.)

FAQs

What does the ADX indicator tell you?

The ADX indicator tells you how strong a trend is. A value of 20 or below indicates a weak trend, while a value of 40 or above indicates a strong trend.

What are the different ADX settings?

The default ADX setting is 14, but other settings can be used. Some traders prefer to use a shorter period, such as 7 or 10 days, while others prefer to use a longer period, such as 21 or 28 days.

Where can I find the ADX indicator?

The ADX indicator is available on most charting platforms. You can also find it online at a variety of websites.

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