What is Average Directional Index (ADX): The ultimate Guide

The Average Directional Index (ADX) 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 (positive directional index or positive direction line) and the other is the -DI (negative directional index or negative direction line). We will explain its calculation later.

Average Directional Index

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

Calculation of the Average Directional Index indicator

To start, we must calculate these two lines that we mentioned previously, for both bearish and bullish movements:

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

  • Maximum of today minus the minimum of today
  • Today's maximum minus the closing of the previous day.
  • Today's minimum minus the closing of the previous day.

Then, what is done is to smooth the results obtained by taking a certain amount of data (Wilder set it at 14). Specifically, an exponential moving average is calculated.

What is ADX 14?

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.

Average Directional Index: 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 Average Directional Index

These trend indicators can be used simultaneously. The average directional index 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 below -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 below +DI) or (ADX decreases.)

👉 Other technical indicators

FAQs

How can one interpret ADX values?

In interpreting ADX values, low values below 20 suggest a weak or absent trend, indicating a consolidating market. Moderate values between 20 and 25 signal the beginning of a trend, marking a transition from consolidation to trending. High values above 25 denote a strong trend, with the trend's strength increasing as the ADX value rises.

Does the ADX provide information about the direction of the trend?

No, the ADX does not provide information about the direction of the trend. Its purpose is to determine if the market is trending or not and assess the strength of the trend. The +DI and -DI lines are used to observe their crossovers, indicating potential uptrends or downtrends.

What does the ADX measure?

The ADX measures the strength of the current trend. It is a normalized oscillator that ranges between 0 and 100. A steeper positive slope of the ADX indicates a stronger trend, while a negative slope suggests no trend or a weakening of the previous trend.

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