Average Directional Index (ADX): Definition and Formula
Some traders use the average directional index (ADX) as a technical analysis indicator to assess the strength of a trend.
The two complementing indicators, the positive directional indicator (+DI) and the negative directional indicator (-DI), indicate whether the trend is going up or down. As a result, the ADX often consists of three distinct lines. These are employed to determine the length and need of a transaction and whether one should be made at all.
Average Directional Index (ADX) Formula
The ADX requires a sequence of calculations due to the multiple lines in the indicator.
Finding the ADX
- For every period, compute the valid range (TR), +DM, and -DM. Usually, fourteen periods are utilized.
- The current high minus the prior high equals +DM.
- Past low – present low is equal to -DM.
- When the current low > the previous low > the previous high > the current low, use +DM. When the current low – previous high > the current high – previous high, use -DM.
- TR is equal to the bigger of the following three: current low (previous close), current high (previous close), or current low (current low).
- The formula for TR is shown below. Smooth the 14-period averages of +DM, -DM, and TR. To find the smoothed averages, enter the -DM and +DM values.
- The total of the first 14 TR readings equals the first 14 TR.
= initial 14TR – (previous 14TR/14) + current TR is the value of the next 14TR. - To obtain +DI, next, divide the smoothed +DM value by the smoothed TR value. Increase by 100.
- To obtain -DI, divide the smoothed DM value by the smoothed TR value. Increase by 100.
- When +DI minus -DI is divided by the total of +DI and -DI (both absolute values), the directional movement index (DMI) is obtained. Increase by 100.
- Continue calculating DX values at least 14 times to obtain the ADX. Next, to obtain ADX, smooth the findings.
- A total of 14 DX periods / 14 equals the first ADX.
- Then, ADX is equal to ((previous ADX * 13) + (current DX) / 14.
What Can You Learn From the ADX?
Momentum indicators include the ADX, negative directional indicator (-DI), and positive directional indicator (+DI). Investors may assess trend strength using the ADX and trend direction using the -DI and +DI indicators.
When the ADX is over 25, it indicates a strong trend; when it is below 20, it indicates a weak trend. Trade signals may be produced by looking for crossovers between the +DI and -DI lines. For instance, an indication to purchase might be present if the +DI line crosses above the -DI line and the ADX is over 20, preferably above 25. However, there may be a chance to enter a short trade if the -DI crosses above the +DI and the ADX is over 20 or 25.
Crosses are also helpful in getting out-of-open transactions. For instance, if the trade is long, exit when the -DI crosses above the +DI. Meanwhile, the indicator indicates that the price is trendless and might not be the best moment to start a trade when the ADX is below 20.
Comparing the Aroon Indicator with the Average Directional Index
The Aroon indicator has two lines, but the ADX indicator has three.
The lines on the two indicators, which show both positive and negative movement and aid in determining trend direction, are comparable. Similar to how the ADX does, the Aroon reading/level also aids in determining trend strength. However, because the computations differ, crossings on each indicator will happen at various times.
Constraints When Using the ADX
Crossovers can happen frequently—sometimes too frequently—which can cause uncertainty and perhaps result in losses on transactions that suddenly turn south. When ADX levels are less than 25, they are more frequent and are called false signals. There are instances when the ADX crosses over 25, but it only stays there momentarily before the price reverses.
To assist in filtering signals and managing risk, the ADX should be used with price analysis and maybe other indicators, just like any other indicator.
A Good Average Directional Index: What Is It?
An ADX greater than 25 is regarded as vital. The price is either not trending at all, or the trend is feeble when the ADX is below 20.
Is ADX a Reliable Source of Information?
However, when paired with pricing, it offers more effective strategy indications. Before selecting the best trading strategy for the situation, investors can utilize the ADX to ascertain whether prices are trending.
Which Indicator Works Best with ADX?
When used with other technical indicators, such as the relative strength index (RSI), the ADX performs best. The RSI gives the trend a time-based component, which may be helpful for entrances and exits, while the ADX quantifies the trend’s strength.
Technical traders utilize the average directional movement indicator (ADX) to assess a trend’s strength and direction. Traders can employ the appropriate technical trading approach after determining if a market trades or ranges using the ADX. This approach is common among traders since it may be profitable and carries little risk. The ADX is not the only technical analysis indicator available; the Parabolic SAR, Moving Averages, and Envelopes are all comparable.
Conclusion
- Welles Wilder created the ADX for commodities daily charts, but technical traders today use it in several markets to assess a trend’s strength.
- In addition to the trendline, the ADX uses positive (+DI) and negative (-DI) directional indications.
- According to Wilder, the price is trendless or weak when ADX is below 20, and the trend is strong when ADX is over 25.
- The price may still be changing, even if it is not trending. It might not be, but the price might change trends or move too quickly for a discernible pattern to exist.
