The average directional index (ADX) indicator measures how strong a market trend is, using moving averages and expressions in units between 1 and 100. The ADX indicator measures the comprehensive strength of a trend and classifies the strength on a scale; traders can decide the likelihood of a trend continuation, pause, or reversal from its strength.
The ADX was invented by J. Welles Wilder in 1978. Wilder was an engineer turned real estate developer turned technical analyst. He is best known for his work on technical analysis, and he also created the Average True Range and Parabolic SAR indicators. Wilder invented the ADX indicator to improve technical analysis and trading outcomes.
The ADX is calculated by averaging the directional movement index (DMI), which measures the difference between the highs and lows of a security over a period of time. The ADX ranges from 0 to 100, with a reading of 25 or higher indicating a strong trend.
How to Calculate and Read ADX
It was initially difficult to interpret the ADX but Wilder became better at it and eventually created the rules that still exist. Here’s how to calculate and interpret the ADX indikator.
To calculate the ADX, you will need to gather the following data:
- The highs and lows of the security for a specified period of time.
- The average true range (ATR) for the security for the same period of time.
Calculate the DMI as follows:
- Positive Directional Movement (PDM) is calculated by taking the difference between the current high and the previous high, and then subtracting the average true range.
- Negative Directional Movement (NDM) is calculated by taking the difference between the current low and the previous low, and then subtracting the average true range.
- The DMI is then smoothed using a moving average. The most common moving average used is the 14-period moving average.
The ADX is then calculated by taking the 14-period moving average of the DMI.
A summary of the formulas are:
1. Calculate the Positive Directional Movement (PDM)
PDM = (Current High - Previous High) - Average True Range
2. Calculate the Negative Directional Movement (NDM)
NDM = (Previous Low - Current Low) - Average True Range
3. Calculate the Directional Movement Index (DMI)
DMI = (PDM + NDM) / 2
4. Calculate the Average Directional Index (ADX)
ADX = 100 * Average of DMI for the specified period of time
The indic;ator ADX can be interpreted as follows:
- A reading of 25 or higher indicates a strong trend.
- A reading of 10 to 25 indicates a moderate trend.
- A reading of 0 to 10 indicates a weak trend.
The average directional movement index indicator automatically executes the formulas and calculates the values based on market data. The indicator:
- can be used to identify trends in both up and down markets.
- can be used to identify overbought and oversold conditions.
- is not a trading signal in and of itself. It should be used in conjunction with other technical analysis tools to make trading decisions