Claire VearesAverage directional index (ADX) is a technical analysis tool that measures the strength of trends. It is a standard analytical tool provided by most trading platforms.
It was developed by J Welles Wilder with commodities in mind but can equally be applied to forex, shares, futures, indexes, cryptocurrencies and ETFs.
ADX indicator has three parts
An ADX chart will usually feature three lines: the ADX, the plus directional indicator (DI+) and the minus directional indicator (DI-).
The DI+ line indicates the strength of positive movement and is calculated by taking away the previous day’s high from the current day’s high.
The DI- line indicates the strength of negative movement and is calculated by taking away the previous day’s low from the current day’s low.
The ADX line indicates the strength of movement over the period.
Strength
ADX is measured on a scale from 0 to 100. The higher the ADX reading, the greater the strength of a trend.
As the ADX is non-directional that trend could be bullish or bearish. A low ADX reading indicates the lack of a meaningful trend. As a guide:
- 0-20 - no trend or a weak trend
- 20-30 - a developing trend
- 30-40 - a strong tend
- 40-60 - a very strong trend
- 60-100 - an extremely strong trend.
It is rare for the extremes of the scale to be reached.
Bearish signs
If the DI- reading starts increasing it could indicate that the asset is on a downward trajectory. At the beginning, the ADX value may be falling or low.
If the asset continues to fall in price the DI- reading will continue to increase. If the fall is great enough the DI- reading will cross over the DI+ line.
This shows that the negative price movement is greater than the positive price movement and the trend is getting stronger. The strength of the trend will be reflected in the ADX value.
ADX can be used as an indicator for short selling if the DI- line is above the DI+ line.
ADX can help identify upward or downward trends: ShutterstockBullish signs
In a bullish market, DI+ will start to go up as the price goes up. The ADX may be falling or be low. As the price continues to rise, DI+ will continue to increase and at some point will cross over DI-, which will stay flat or fall.
The crossover indicates that positive price movement is stronger than negative price movement. ADX will also increase, showing that the trend strength is increasing.
Trend reversal
The DI+ and DI- lines meeting can indicate a change of trend. When the DI+ crosses above the DI- line it signals a potential upward trend, while the DI+ line dropping below the DI- line signals a potential downward trend.
Lagging behind
ADX is a lagging indicator as it uses historical price movement information to look for trends and to indicate the strength of any trends. As ADX does not show whether that trend is upwards or downwards, it is best read together with the directional indicators, DI+ and DI-.
Picks
ADX trading is a good way of working out which stocks, for example, are trading within their normal range and which merit further inspection. A filter can be employed to look only at stocks with an ADX of above 20, say. This will pick out those that are on a trend, whether up or down.
If the ADX reading is exceptionally high it could well indicate that the trend is likely to come to an end soon. If a high ADX reading starts to fall it indicates that there is still a trend but it is weakening and it might be time to take the profit and close the trade.
Merits
Like all analysis tools, ADX is best used together with other indicators to get an overall picture of the investment markets you are interested in. Taking the DI+ and DI- readings into account together with the average will give further clues.
ADX trading is a good way of spotting the strength of trends and for identifying assets that are having a bit of a moment from those that are quite happily doing exactly what they usually do.