The ADX (Average Directional Index) is a technical analysis indicator used to know if prices are in trend or in range and to measure the strength of the trend. It is a non-directional oscillator type indicator, that is, it quantifies the strength of a trend regardless of its direction. In Spanish ADX means average direction index.
It is essential for a technical analyst to know what the price trend is. With the ADX indicator you can measure the strength of this trend. The ADX ranges between 0 and 100 (as does the RSI ) and is calculated according to the differences between DI + and DI-. These technical indicators were developed by Welles Wilder in the 80s.
It is common to use it together with the directional movement indicators (DMI), which show us the predominant market trend.
How to use the ADX indicator
When the ADX is greater than 30, the market is in a strong trend, when it is between 20 and 30 it is not well defined and when it is less than 20 it indicates that the market is in range. The most common ways to use ADX are:
- Knowing the strength of a trend:when the ADX has a positive slope and / or is situated at levels between 30 and 40, it indicates strength of trend. In strong trend movements (either bullish or bearish) the speculator takes advantage of the downward corrections (upward trend) to buy the value and rebounds (downward trend).
- To know when a range comes to an end:when the ADX is below 20-30 and / or is between the directional motion lines. With prices in range, speculators buy at the bottom and sell at the top, the ADX lets them know when that range ends. In addition, the signal that a range ends means that a new trend begins, so speculator will only have to get on it.
- Determine trend changes:when there are too high divergences (above 45-50) it means that the trend is running out or losing strength. So you probably take a break. On the contrary, when these divergences are above 30, but in not very high readings we understand that the trend is strengthening.
How to calculate the ADX indicator
As we have commented, the ADX is built with the directional indicators, DI + and DI. Specifically the difference between them divided by their sum:
+ DI is the line of the positive direction indicator.
– DI is the line of the negative direction indicator.
The + DI and –DI measure the presence of upward and downward movements, respectively. They are calculated as follows:
Where + DM is the sum of the positive movements, -DM is the sum of the negative movements and TR is the true range, which is in the case of positive movements, the largest of these three:
- The maximum of the day minus the minimum
- The maximum of the day minus yesterday’s close
- Yesterday’s closing minus the minimum of the day
ADX indicator example
The ADX can be presented in two ways: only the ADX line or together with the directional motion lines. Let’s see both cases:
With directional motion lines (DM):