Average Directional Index ADX: Definition and Formula

what is adx

For instance, a 5-period ADX will reach high readings much more frequently than a 20-period ADX. There are many trading indicators that promise to help you find profitable trading opportunities. J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor. Read price first, and then read ADX in the context of what price is doing. When any indicator is used, it should add something that price alone cannot easily tell us.

How does the ADX indicator work?

In addition to the ADX line, the indicator also includes two other lines known as the “Directional Movement Index” (DMI) and the “Directional Movement Indicator” (DMI). The DMI consists of two lines, one representing the positive price movement (the “plus DMI”) and the other representing the negative price movement (the “minus DMI”). The DMI is then calculated by subtracting the plus DMI from the minus DMI. The DMI can be used to identify the direction of the trend, with a reading above 25 indicating an upward trend and a reading below -25 indicating a downward trend.

what is adx

How to use average directional movement index?

If the ADX is moving from above to below 25 then it resembles that the trend is becoming weak. We require that DMI-plus is above DMI-minus and that the 14-period ADX is below 20, to enter a trade. Another way is to combine ADX with another indicator, particularly one that identifies whether the pair is headed downwards or upwards.

Average Directional Index (ADX) Formula

what is adx

After weve determined the DX, we can now smooth its value, thus creating the ADX. If, for example, we are using a 14-day ADX, the first ADX is simply a 14-day average of the Directional Index. Having explained the basics of the calculation, you can see what the link between the -DI and +DI and ADX is. Now, as you increase the length of the ADX, you’ll start to notice how it becomes less responsive and less likely to go into the really high readings.

The Average Directional Index vs. The Aroon Indicator

A series of ADX peaks is a visual representation of overall trend momentum. ADX can be used with any financial security that trades, including stocks, mutual funds, exchange-traded funds, and futures. ADX is a leading indicator that is used to predict where to buy and sell the shares to get the maximum profit.

Unlike other technical indicators, ADX readings above 60 do not occur frequently. Currently, ADX (the orange line) is near 27, which suggests a strong trend. It is the primary indicator among the five indicators that make up a technical trading system. Wilder was a mechanical engineer turned real estate investor https://traderoom.info/what-is-adx-trend-indicator/ and developer. He later became a full-time market and trading researcher, making major advances in the field of technical analysis. It is also important to consider the length of the period used to calculate the ADX and to choose a period that is appropriate for the type of market and instrument being traded.

Even though the differences between this and the previous image aren’t that significant, they are big enough. The Negative Directional Movement (-DM), is equal to the current low minus the previous low, if it’s bigger than +DM and greater than zero. If the red line(-DI) is higher than the green line(+DI) that is generally an indication of a bearish trend. Conversely, if the green line(+DI) is higher than the red line(-DI) that is generally an indication of a bullish trend. What’s fascinating about the book is that they were written before the computer age, where many calculations still were made by hand. Still, the book outlines detailed instructions on how the ADX is calculated, which would take a substantial amount of time to be performed by hand.

It’s often used as a filter to enhance an existing trading strategy, by removing a lot of unwanted and losing trades. While the ADX calculations are complex, the interpretation is straightforward, but successful implementation takes practice. Like any technical analysis tool, the ADX should be combined with price analysis and potentially other indicators to help filter signals and manage risk. Being aware of a rising trend momentum gives traders confidence to keep the position instead of exiting before the trend has ended. Similarly, a series of lower ADX peaks can signal the trader to keep an eye on price and ensure that their risk-management technique is in place. Since, of course, the most profitable trading decisions are made on objective signals and not emotion.

A fourth pitfall is that the ADX may give false signals if it is used in isolation. The ADX is a lagging indicator, which means it is based on past price data and may not necessarily predict future price movements. At its core, the ADX is designed to provide a numerical indication of the strength of a trend, as well as whether that trend is currently bullish (upward) or bearish (downward). It does this by measuring the level of price movement in a given market over a specific period of time.

It is used to measure the positive price movement in a financial market over a specified period of time. Irrespective of whether the trader takes a long or short position, the ADX should be over 25 when the crossover occurs to confirm the trend’s strength. When the ADX is below 20, traders could use trading strategies that exploit range bound or choppier conditions. To sum up, the Average Directional Index is a great tool for technical analysis and determining the strength of a trend, whether it be going up or down. Pair it with other indicators to analyze trends and find when it is a good time to place a trade, given market status.

  1. Together, these indicators help assess whether a trade should be taken long or short, or if a trade should be taken at all.
  2. It is a popular tool among traders and investors, as it can help them identify trends and decide on appropriate trading strategies.
  3. The ADX can be used to measure the trend strength of basically any investment you can trade, including single stocks, mutual funds and exchange-traded funds.
  4. ADX will meander sideways under 25 until the balance of supply and demand changes again.
  5. Similar to support and resistance levels, these zones highlight areas…

Even though the market is quite calm with only slightly higher ADX readings, we clearly see how ADX readings between 15 to 20 indicate that the market is trending somewhat. The calculation of ADX begins with determining the plus and minus directional movement, which is also called DM. The first appearance of the ADX indicator was in Wilder’s book “New Concepts In Technical Trading Systems”, released in 1978.

That’s why we recommend investing 15% of your income in tax-advantaged retirement accounts like your 401(k) and Roth IRA. Lionel owns several shares of stock in a company, and he sees that the stock’s price has been rising a lot over the past month. Now he’s wondering if he should sell his shares now or if he should hold on to them for a little while longer.

It’s important to consider these factors when interpreting the ADX and using it in your technical analysis. The plus DMI is typically plotted separately on a chart https://traderoom.info/ and can be used to identify upward trends in a market. Let’s look at an example to see how a stock trader might use the ADX indicator to make investing decisions.