The Average Directional Index (ADX) is a technical analysis indicator that is widely used by traders to determine the strength of a trend. It was developed by J. Welles Wilder in 1978, and it remains a popular tool for traders looking to identify the strength of a trend in a particular asset.
In this article, we will explain what the ADX is, how it works, and how to use it to make better trading decisions. We will also provide a formula and an example of how to use the ADX.
What is Average Directional Index (ADX)?
The ADX is an indicator that measures the strength of a trend, regardless of whether it is an uptrend or a downtrend. The ADX value ranges from 0 to 100, with higher values indicating stronger trends. A value of 0 indicates a non-trending market, while a value of 100 indicates an extremely strong trend.
The ADX is calculated based on the difference between two directional movement indicators (DMI), namely the Positive Directional Indicator (+DI) and the Negative Directional Indicator (-DI). The +DI and -DI indicators measure the upward and downward movements of an asset, respectively. The ADX is calculated using the following formula:
ADX = 100 times the exponential moving average of the absolute value of (+DI – -DI) divided by the exponential moving average of the true range
The true range is the greatest of the following three values:
- Current high minus current low
- Absolute value of current high minus previous close
- Absolute value of current low minus previous close
How to use Average Directional Index (ADX)?
Traders can use the ADX to determine whether a particular asset is in a strong trend or not. A high ADX value indicates a strong trend, while a low ADX value indicates a weak trend or a non-trending market.
Traders can also use the ADX to identify potential buy or sell signals. For example, when the ADX is above a certain threshold, such as 25 or 30, it indicates that the trend is strong, and traders may want to consider entering a trade in the direction of the trend. Conversely, when the ADX is below a certain threshold, it indicates that the trend is weak, and traders may want to consider staying out of the market until a stronger trend develops.
Example of Average Directional Index (ADX)
Let’s take a look at an example of how to use the ADX. Suppose the +DI and -DI values for a particular asset are as follows:
+DI = 40 -DI = 30
The true range for the asset is 2.5. The ADX is calculated as follows:
ADX = 100 times the exponential moving average of the absolute value of (+DI – -DI) divided by the exponential moving average of the true range
ADX = 100 times the exponential moving average of (|40 – 30|) / 2.5 divided by the exponential moving average of 2.5
ADX = 40
A value of 40 indicates a moderate trend, but it is not a strong trend. Traders may want to consider staying out of the market until a stronger trend develops.
Conclusion
The Average Directional Index (ADX) is a powerful technical analysis tool that helps traders determine the strength of a trend in a particular asset. The ADX is easy to calculate and interpret, and it can be used in conjunction with other technical indicators to confirm trading signals. Traders should always use the ADX in conjunction with other technical and fundamental analysis tools to make better trading decisions.