Trading in the direction of a strong trend reduces risk and increases profit potential. The average directional index (ADX) is used to determine when price is trending strongly. In many cases, it is the ultimate trend indicator. After all, the trend may be your friend, but it sure helps to know who your friends are. In this article in this article, we'll examine the value of ADX as a trend strength indicator.

Introduction to ADX
ADX is used to quantify trend strength. ADX calculations are based on a moving average of price range expansion over a given period of time. The default setting is 14 bars, although other time periods can be used. ADX can be used on any  trading vehicle such as stocks, mutual funds, exchange-traded funds and futures. (For background reading, see Exploring Oscillators and Indicators: Average Directional Index and Discerning Movement With The Average Directional Index - ADX.)

ADX is plotted as a single line with values ranging from a low of zero to a high of 100. ADX is non-directional; it registers trend strength whether price is trending up or down. The indicator is usually plotted in the same window as the two directional movement indicator (DMI) lines, from which ADX is derived (Figure 1).

For the remainder of this article, ADX will be shown separately on the charts for educational purposes.
 

Source: TDAmeritrade Strategy Desk

Figure 1: ADX is nondirectional and quantifies trend strength by rising in both uptrends and downtrends.

When the +DMI is above the -DMI, prices are moving up, and ADX measures the strength of the uptrend. When the -DMI is above the +DMI, prices are moving down, and ADX measures the strength of the downtrend.