ADX: The Trend Strength Indicator

Average Directional Index

Technical analysis, on the other hand, uses charts and various other technical indicators to forecast market conditions. The major purpose of the (ADX) indicator is to find out whether a stock, currency pair or commodity is trending in a direction or stuck in a range. Often used as a complement to other technical indicators, the ADX is a strong factor in deciding whether to buy or sell an asset. A succession of higher peaks means that trend momentum is rising, whereas a succession of lower peaks means that trend momentum is falling. Therefore, the lower peaks act as a signal for the trader to ensure that their risk-management technique is in place, in case of a quick change in momentum.

Average Directional Index

Applying this strategy requires you to place a buy order when the price is going down, the ADX is above 25, and the RSI is below 30. On the other hand, if the price is ranging high, the ADX is above 25, and the RSI is above 70, you can consider the market overbought and open a short position. The most common signal that the market is ranging is when the indicator drops below 25 but doesn’t surpass 20. Alternatively, this is when the trend is slowing down, but still not enough to be considered weak. One of the trickiest parts of trading is capturing the moment price patterns move from trending to ranging. The divergence signals generated by the ADX are very similar to those from oscillators like the MACD or the RSI.

Indicators, Strategies and Libraries

It would have been prudent to ignore bearish signals with a bullish continuation pattern taking shape. By contrast, the June 2010 buy signal occurred near a resistance zone marked by broken support and the 50-62% retracement zone. In this instance, it would have been prudent to ignore a buy signal so close to this resistance zone.

Much like RSI and stochastics, ADX fluctuates between 0 and 100. The bottom part of the chart below demonstrates what the ADX indicator looks like. First, use ADX to determine whether prices are trending or non-trending, and then choose the appropriate trading strategy for the condition. In trending conditions, entries are made on pullbacks and taken in the direction of the trend. In range conditions, trend-trading strategies are not appropriate.

What Is The Average Directional Index (ADX)?

EUR/CHF broke below the bottom of the range and went on a strong downtrend. When you’re using the ADX indicator, keep an eye on the 20 and 40 as key levels. It is based on comparing the highs and lows of bars and does not use the close of the bar. When the ADX has risen above 50, this indicates that the price has picked up momentum in one direction. The calculation example below is based on a 14-period indicator setting, as recommended by Wilder. Directional movement is negative (minus) when the prior low minus the current low is greater than the current high minus the prior high.

Average Directional Index

It is a set of MAs with different periods that show four stages of a trend – beginning, active phase, weakening trend, and flat. Unfortunately for many traders, price movements aren’t just a game of ups and downs. Often, the most accurate trading signals are in the strength of the trend.

Trading strategy

From a technical analysis perspective, a rising stock in a strong uptrend may suggest greater likelihood of continuing to rise than the same stock whose uptrend is showing signs of weakness. The Average Directional Index (ADX) is used to measure the strength or weakness of a trend, not the actual direction. In general, the bulls have the edge when +DI is greater than -DI, while the bears have the edge when -DI is greater.

  • J. Welles Wilder, born in 1935, was an American mechanical engineer turned real estate developer, best known, however, for his technical analysis work.
  • The trend’s strength means how much the buying volume exceeds the selling volume or how much the selling volume exceeds the buying volume.
  • To quantify the trend’s strength, the calculation of the Average Directional Index is based on a moving average of a price range expansion over a certain timeframe.
  • While the ADX calculations are complex, the interpretation is straightforward, but successful implementation takes practice.
  • EUR/CHF broke below the bottom of the range and went on a strong downtrend.

A strong trend emerged after the August bottom as ADX moved above 20 and remained above 20. Before looking at some signals with examples, keep in mind that Wilder was a commodity and currency trader. The examples in his books are based on these instruments, not stocks.

Using the ADX Indicator

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What does the ADX indicator tell you?

ADX values help traders identify the strongest and most profitable trends to trade. The values are also important for distinguishing between trending and non-trending conditions. Many traders will use ADX readings above 25 to suggest that the trend is strong enough for trend-trading strategies.






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