Average Directional Index, known in Portuguese as the Average Directional Index, is an indicator used to measure the strength of each trend.
Created in 1978 by Welles Wilder (one of the greatest experts in this type of analysis), it is described in detail in the book “New concepts in technical trading systems”.
The reading of the Average Directional Index (ADX) is linked to the knowledge of other indicators created by this same author, which, when combined, still indicate the “direction” factor of the trend.
Due to the enormous popularity it acquired with operators, ADX became one of the most famous tools used in technical analysis.
How does the Average Directional Index work?
Before we start reading the ADX itself, it is important that you understand the operation of two other indicators.
The first, called the Positive Directional Index (or its acronym: + DI ), indicates an upward trend.
The second, called the Negative Directional Index (or the acronym: -DI ) indicates a downward trend.
There is no need to use any absurd formula to understand that when + DI is higher than -DI, prices are inclined to rise.
The opposite happens when -DI exceeds + DI . That is, at that moment, the price slope is to fall .
When + DI and -DI meet, what we call a trend reversal happens .
Therefore, it is from reading these two indicators that the direction of the trend is identified . In other words, where the price goes.
ADX is not able to perform this indication and that is why the three are used together in the readings.
Now, yes, we can proceed with the calculation of ADX in a much easier way to follow!
In general, ADX is calculated from the moving average for the last 14 days.
It oscillates on a scale of 0 to 100, with 0 representing the weakest level of a trend and 100 the strongest level.
In practice, intermediate levels are the most frequent and, therefore, the most important for readings.
Thinking in a tabulated way, the scale is separated as follows.
From 0 to 25 , there are weak trends, which usually do not represent any significant movement in the market.
From 25 , the trend starts to strengthen.
The point of the cat, here, is to be able to identify it even in the rise of the second decade and, thus, to draw in advance strategic entrances or exits.
At 50 , ADX is already in a very strong trend. If it exceeds 75 (which is rare), it reaches the last level of suitable force.
What are the advantages of using the Average Directional Index?
As we said at the beginning, ADX is already one of the most popular devices in technical analysis.
Being able to identify the strength and direction of a trend, you can base or confirm strategies – an end for which it is excellent, especially when it comes to entry points and exit points.
Do you remember what you learned above when we talk about + DI and -DI? They will also assist you in this process.
The earlier you are able to identify the rising strength of trends (from the first to the second level), the greater your chances of positioning yourself and earning more.
However, take it easy! If your reading is incompatible with the reality, you can also lose a lot of money.
After all, ADX is indicative and not a crystal ball.