12 Jul 2019
What is the Average Directional Index?
Trend indicators are a popular class of technical indicators for both short-term and long-term traders. These indicators help quantify the overall strength of a trend. One of them is the Average Directional Index or Average Directional Movement Index, also known as ADX. Along with the Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI), the ADX forms a group of directional movement indicators, in a part of the trading system developed by Welles Wilder. Although Wilder designed these indicators with commodity and daily price action in mind, they can also be used in the currency and stock markets. Wilder developed the system along with Parabolic SAR and Average True Range (ATR), much before the electronic or computerised age of trading. Even then, they were incredibly detailed in their calculations and have helped many traders through the years.
In case the ADX is below 30 for consecutive 30 bars, prices tend to start ranging and become easier to identify. Then, they start fluctuating between the resistance and support levels, to generate selling and buying interests, respectively. It is when the ADX is above the value of 25 that prices begin to trend.
The direction of the ADX line also determines the trend strength. When the line rises, it signals an increase in strength, when prices start moving in the direction of the trend. When the line falls, prices retrace or consolidate. Contrary to common belief, a declining line doesn’t necessarily indicate trend reversal. It only indicates a weakening trend. As long as the value is above 25, the trend exists.
Calculations of Average Directional IndexThe ADX indicator, together with two accompanying indicators (+DI and –DI), forms three separate lines. These lines help traders assess whether to go for a long or short position or avoid entering a trade at all. ADX requires a sequence of calculations for the three lines: +DI = (Smoothed +DM/ATR) X 100 - DI = (Smoothed –DM/ATR) X 100 DX = (|+DI - -DI|/ |+DI + -DI|) X 100 ADX = ((Prior ADX X 13) + Current ADX) / 14 Where: +DM (Directional Movement) = Current High – Previous High -DM = Previous low – Current low TR = Greater of the (Current High - Current Low, Current High - Previous Close, or Current Low - Previous Close) Smoothed +/-DM = Smoothed 14-period average of +DM, -DM, and TR CDM = Current DM and ATR = Average True Range
How Does It Work?ADX calculations are based on the moving average of price expansion for a specific period of time. While the default setting is 14 bars, other time periods can be used as well. Together, the three indicators act as momentum indicators, with ADX signifying trend strength, and +DI and –DI showing the trend direction. By determining the values of ADX, traders can ascertain whether a particular trend is strong enough to continue. A value above 25 signifies strength, while below 25 is usually avoided by traders.
|ADX Value||Trend Strength|
|50-75||Very Strong Strength|
|75-100||Extremely Strong Strength|