Average Directional Index (ADX)
Parameters
- Periods: The period setting, set to 14 in default, determines the number of data points (e.g., days) used in calculating the ADX. The ADX is a trend strength indicator, and a familiar setting is 14 periods, which smooths out the data to provide a clearer view of the trend\'s strength over two weeks (if using daily data).
- Style: These settings allow customization of how the ADX indicator is displayed on the chart, including the panel placement, line style, and color.
The Average Directional Index (ADX) is a technical analysis instrument that evaluates the robustness of a market trend. The ADX is non-directional, meaning it does not indicate trend direction but rather the strength of a trend, be it upwards or downwards. It is a component of the Directional Movement System developed by Welles Wilder. It is often used in combination with the Plus Directional Indicator (+DI) and Minus Directional Indicator (-DI) to produce the Directional Movement Indicator (DMI).
How ADX Works: The ADX is calculated using a sequence of calculations designed to smooth out the results to represent trend strength accurately. These calculations involve the True Range, which encompasses the current high less the current low, the current high less the previous close, and the current low less the previous close, to capture the movement scope for each period.
Here are the essential steps for calculating ADX:
Calculate the True Range Plus Directional Movement (+DM) and Minus Directional Movement (-DM) for each period.
Smooth these values over a selected period (commonly 14 days) to obtain the Average True Range (ATR), Average +DM, and Average -DM.
Calculate the +DI and -DI by dividing the smoothed +DM and -DM by the ATR and multiplying by 100 to get a percentage.
The Directional Movement Index (DMI) is formed from the +DI and -DI values.
Determine the DX, or Directional Index, by calculating the absolute difference between +DI and -DI divided by the sum of +DI and -DI.
Smooth the DX values to get the ADX. The smoothing process involves a modified moving average calculation.
Key Aspects of (ADX):
Trend Strength: The value of the ADX generally ranges from 0 to 100, with values around 20-25 or lower indicating a weak trend, while values above 25 suggest a strong trend.
Trend Direction: To identify the trend direction, traders look at the +DI and -DI. When +DI is above -DI, the price moves upward, and when -DI is above +DI, the price moves downward.
Non-Directional: Since the ADX only measures the trend strength, not the direction, it can be used alongside other indicators to determine the trend direction.
Application of ADX: Traders often use the ADX to confirm whether a trend is worth following. They may enter a trade when the ADX rises, indicating that the trend is strengthening. They may also use the crossing of +DI and -DI to signal potential entry points, although it is not the primary function of the ADX.
Limitations:
The ADX does not give any indication of the trend direction.
This indicator is a lagging one, reflecting historical price movements, and it may not necessarily forecast the direction of future prices. High ADX values can sometimes be misleading, as they may persist even when the trend begins to flatten out.
Conclusion: The ADX is a versatile and widely used indicator that assists traders in identifying when a trend is strong enough to enter a trade. While it doesn\'t provide trade signals independently, it is an essential part of the DMI system and is best used with other indicators for making informed trading decisions. As with all indicators, the ADX should be integrated into a thorough trading plan that includes various considerations for when to enter and exit trades.