Average Directional Index - ADX

What

The ADX is an indicator used in technical analysis as an objective value for the strength of a trend. ADX is non-directional so it will quantify a trend's strength regardless of whether it is up or down. The ADX is plotted as an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. ADX is usually plotted in a chart window along with two lines known as the DMI (Directional Movement Indicators). ADX is derived from the relationship of the DMI lines.

How

The ADX is a combination of two other indicators developed by Wilder, the positive directional indicator (abbreviated +DI) and negative directional indicator (-DI). The ADX combines them and smoothes the result with an exponential moving average.

To calculate +DI and -DI, one needs price data consisting of high, low, and closing prices each period (typically each day). One first calculates the Directional Movement (+DM and -DM):

Up Move = Today's High - Yesterday's High

Down Move = Yesterday's Low - Today's Low

if Up Move > Down Move and Up Move > 0, then +DM = Up Move, else +DM = 0

if Down Move > Up Move and Down Move > 0, then -DM = Down Move, else -DM = 0

After selecting the number of periods (Wilder used 14 days originally), +DI and -DI are:

+DI = exponential moving average of +DM divided by Average True Range

-DI = exponential moving average of -DM divided by Average True Range

The exponential moving average is calculated over the number of periods selected, and the average true range is an exponential average of the true ranges. Then:

ADX = 100 times the exponential moving average of the Absolute value of (+DI ? -DI) divided by (+DI + -DI)

Variations of this calculation typically involve using different types of moving averages, such as a weighted moving average or an adaptive moving average.

When

The ADX indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. A reading above 40 can indicate a strong downtrend as well as a strong uptrend.

ADX can also be used to identify potential changes in a market from trending to non-trending. When ADX begins to strengthen from below 20 and moves above 20, it is a sign that the trading range is ending and a trend is developing.

When ADX begins to weaken from above 40 and moves below 40, it is a sign that the current trend is losing strength and a trading range could develop.