The average directional index (ADX) measures the strength of a prevailing trend and whether movement exists in the market. The ADX is measured on a scale of 0 to 100. A low ADX value (generally less than 20) can indicate a non-trending market with low volumes, whereas a cross above 20 may indicate the start of a trend (either up or down). If the ADX is over 40 and begins to fall, it can indicate the slowdown of a current trend. This indicator can also be used to identify non-trending markets, or a deterioration of an ongoing trend. Although market direction is important in its calculation, the ADX is not a directional indicator.

Many technicians who use ADX on a regular basis use a 14-unit ADX (meaning 14 trading days) and end-of-day data (the closing prices of each security being studied). It is important to use the same parameters in each study to reveal consistent findings. Make sure that you never have more than two or three indicators in your studies, allowing for quick decisions to be made when an issue is making a strong move in either direction. (For some background reading, check out our Exploring Oscillators And Indicators Tutorial and Getting Confirmation with the Momentum Strategy.)

Finding a Strong Trend

An ADX above 30 on the scale indicates there is a strong trend in that particular time frame. Recall the principle that momentum precedes price. Therefore, when using ADX in your studies, note that when ADX forms a top and begins to turn down, you should look for a retracement that causes the price to move toward its 20-day exponential moving average (EMA). In an uptrending market, the technician will buy when the price falls to or near the 20-unit EMA, and in a downtrending market, one should look to sell when the price rises to or near its 20 unit EMA.

Investors should know that ADX does not function well as a trigger. Prices will always move faster than the ADX, as there is too much of a smoothing factor, which causes it to lag the price movement.

Interestingly, when ADX drops below 18, it often leads to a sideways or horizontal trading pattern, and the moving averages start to cluster around the price of the security. This signifies basing action within a trading range from which it is possible to draw support and resistance lines. Classic technical analysis tells us the longer the price action moves horizontal, the more likely the chart pattern will be a reversal pattern rather than a continuation pattern. When ADX moves down that low, you are in a breakout mode, and once the price breaks out, you could be setting a new trend. So draw your trendline and look for some type of breakout method.

ADX Weaknesses

Each indicator has its weaknesses and the ADX is no exception. Imagine that you have a nice long base, and jump aboard when ADX starts rising from a low level. If you successfully carry this trade all the way up to a high ADX level - somewhere above 30 - and then the market turns down, the ADX will start to decline. This decline suggests an absence of trending direction, but the price does not have an absence of direction: it is moving down.

In other words, with all the smoothing and other data that is used to determine the plotting of the ADX, we are actually looking at 30 days of data versus the 14 that we use as a default in our software models.

An Example

Figure 1: Average directional index for ORCL, June through April 2001.

As you can clearly see in this chart of Oracle Corporation, (ORCL), the downtrend from the summer of 2001 is indicated with a strong ADX trend direction and immediately turns down as the market falls off. two sell signals and a buy signal have been indicated.

The Bottom Line

The average directional index (ADX) measures the strength of a prevailing trend and whether movement exists in the market. However, this indicator does not work well as a trigger, because prices always move faster than the ADX. ADX is best used as an indicator of trend strength,

Related Articles
  1. Technical Indicators

    Explaining Autocorrelation

    Autocorrelation is the measure of an internal correlation with a given time series.
  2. Chart Advisor

    ChartAdvisor for October 9 2015

    Weekly technical summary of the major U.S. indexes.
  3. Chart Advisor

    These Oil & Gas Stocks Have Reversed

    It's been a long downtrend for oil stock owners, but there's hope. These four oil and gas stocks have reversed and may keep trending to the upside.
  4. Chart Advisor

    Bumpy Roads Ahead In Transportation

    Investors are keeping an eye on the transportation industry. We'll take a look at the trend direction and how to trade it.
  5. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  6. Chart Advisor

    4 European Stocks to Consider Buying

    European companies, listed on US exchanges, that are providing buying opportunities right now.
  7. Chart Advisor

    ChartAdvisor for October 2 2015

    Weekly technical summary of the major U.S. indexes.
  8. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  9. Technical Indicators

    Why MACD Divergence Is an Unreliable Signal

    MACD divergence is a popular method for predicting reversals, but unfortunately it isn't very accurate. Learn the weaknesses of indicator divergence.
  10. Chart Advisor

    Weakness In Biotech Will Likely Continue

    You can breathe easy with your biotech holdings--assuming you aren't counting on them to make you rich.
  1. What are the main signals traders use when following the Average Directional Index ...

    The average directional index, or ADX, is one of several indicators created by technical analyst J. Welles Wilder Jr. Specifically, ... Read Full Answer >>
  2. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  3. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  4. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  5. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  6. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  3. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!