Average Directional Index (ADX)

By mosesbet · Filed Under Spread Betting Comments Off on Average Directional Index (ADX) 

The Average Directional Index (ADX) is another indicator developed by Welles Wilder (he also invented the Relative Strength Index).  Unlike the RSI and the Stochastic Oscillator which can both identify emerging trends, the ADX purely measures the strength of the trend.

What is the Average Directional Index (ADX)?

The Average Directional Index is typically used to measure the strength of trends.  The backbone of the ADX is made up of the Plus Directional Movement (+DI) and the Minus Directional Movement (-DI). Directional Movement is positive when the current high minus the prior high is greater the prior low minus the current low.  In other words, Directional movement is positive when +DI (different between current high and prior high) is greater than -DI (prior low minus current low).

The ADX is plotted on a chart of 1-100. Normally if the ADX is less than 25 then it shows a weak trend, i.e. the market is ranging.  Sometimes spread bettors use 20 or 30 instead of 25.

If the ADX is higher than 50 then it shows a very strong trend occurring in the market.

The downside the using the ADI is that unlike the Stochastic Oscillator or RSI it doesn’t identify which way the market is trending. This has to be left to your own devise or you can use the ADX in concatenation with one of these other technical indicators to find the price pattern and whether it’s moving upwards or downwards.

How to Use the ADX

The correct way to use the ADX is to identify price reversals and then place an order when the ADX identifies a strong trend.  For example, if the ADX is above 30 and the +DI is above the DI then it indicates a strong uptrend and you should take advantage of this pullback.

On the other hand, if the ADX is above 30 but the –DI is above the +DI then it shows the formation of a strong downtrend and you should sell your positions or go short. If the +DI and –DI figures are moving sideways and the ADX is <30 then it shows there is no trend and you shouldn’t be doing anything.

The ADX can also be used to help spot trends or price reversals as the –DI and +DI cross each other.  If the +DI crosses above the –DI for example then it probably means the market is going to trend upwards, while if the –DI crosses above the +DI then the market might be trending downwards.

In conclusion, the ADX is a really useful instrument for testing the strength of trends and whether they will continue trending or whether the market prices will flatten out.  The downside to the ADX is that it can lag price a little (since it’s based on a average of the last 14 days of data) and it doesn’t identify which way the market is trending.

 

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