Average Directional Index (ADX)

What is it?

ADX is a lagging trend indicator designed by J Welles Wilder and indicates the strength of a trend, or when a stock is in a strong uptrend or downtrend, or whether it's moving sideways. It is part of an indicator system called Wilder's DMI, which was first introduced in J. Wells Wilder's book, New Concepts in Technical Trading Systems of 1978. Wilder's DMI consists of three lines: the +DI line, the -DI line and ADX line but the ADX can also be used on its own, and on any trading time frame to help you determine key turning points in the market. The ADX is an oscillator that fluctuates between 0 and 100, with values above 40 generally indicating a strong trend and values below 20 indicating a weak trend or flat trading ranges.

However, the ADX does not indicate if the trend as bullish or bearish. It merely indicates the strength of the current trend. Thus a value above 40 can indicate a strong uptrend as well as a strong downtrend. Extremely high values indicate that the trend will likely come to an end.

Also, ADX does not give entry or exit signals. It does, however, give you some perspective on where the stock is in the trend. Low readings and you have a trading range or the beginning of a trend.

How is it used?

Generally, stocks that are in a strong uptrend should be bought and held until one or more momentum indicators, such as the RSI or CCI indicate a sign of weakness. Stocks that are in a trading range, i.e., moving sideways within a tight range should be analyzed using an oscillator indicator, such as the stochastic oscillator for entry and exit points.

When ADX is between 0 and 20 it indicates that the stock is in a trading range and you'd need an oscillator indicator to determine entry and exit points.

When ADX moves above 20 it indicates the beginning of a trend, though it could be an uptrend or a downtrend so remember to verify whether it is an uptrend or a downtrend before you commit to the trade.

When ADX moves above 30 it indicates the start of strong trend! This is the best time to enter a trade!

Once ADX moves above 50 it becomes more probable that the trend is coming to an end and trading ranges developing again.

Chart Example

The following chart shows a 13-period Wilder's DMI in the lower chart panel on a 30-minute chart of the Dow Jones Industrial Index. The green line is the ADX line while the blue line is the +DI line and the red line is the -DI line.

DOW chart with ADX
ADX on a 30 Minute DOW chart

Wealth Warning

Trading equities, options, derivatives, currencies, commodities or any other financial security can offer significant returns BUT can also result in significant losses if the market moves against your position. It requires a strong commitment to skill development, knowledge acquisition, and emotional control. It should be treated as a business with a clear business plan, a risk analysis, and set of attainable goals. The risk associated with trading the vagaries of the stock markets is probably the most important consideration as it has a profound effect on emotional control. You should not trade the stock markets with money you cannot afford to lose as there is considerable exposure to risk in any stock market transaction.

Furthermore, the past success of any trading method, strategy, or system is only indicative of future success. Under no circumstances should past success be construed as a guarantee of future success!

Trend Indicators

A Trend Indicator (MACD)

The main purpose of a trend indicator is to identify the existence and direction of a trend. These indicators accomplish this by smoothing the price action of a security and tend to be lagging indicators as they are based on past price action. Thus, they tend to follow price action and are sometimes referred to as trend following indicators.

By far the most common trend indicator is the moving average (MA). Other trend indicators include Average Directional Index (ADX), Parabolic SAR, Price Oscillator, Zig Zag and Trend Lines. How the trend is determined ...

Relative Strength Index (RSI)

Relative Strength Index
Relative Strength Index

The Relative Strength Index (RSI) is one of the most useful momentum indicators around and is one of the most widely used oscillating indicators. The RSI determines overbought and oversold conditions by compares the magnitude of a security's recent gains to the magnitude its recent losses.

RSI is calculated using the formula: RSI = 100 - 100/(1 - RS) where RS is (Average Gain) / (Average Loss) for the specified period. However, Average Gain and Average Loss are not true averages as they are divided by the period of the RSI. The RSI varies between 0 and 100 ...

J. Welles Wilder, Jr.

Wilder's RSI
Welles Wilder's RSI

J. Welles Wilder, Jr., developed a keen interest in the stock markets in the 1970. Approaching the stock market from an engineering perspective, Wilder set about trying to identify mathematical models that could be used profitably to trade what appeared to be random price movements.

Wilder's studies let him to discover a number of mathematical models on which much of modern day technical analysis is based. These mathematical models included technical indicators such as the RSI, Parabolic SAR, and DMI, which have become some of the most widely used ...

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