Exploring Oscillators and Indicators: Average Directional Index
The average directional index (ADX) is a trend indicator used to measure the strength and momentum of an existing trend. This indicator's main focus is not on the direction of the trend but with the momentum.
The ADX is a combination of two price movement measure, the positive directional indicator (+DI) and the negative directional indicator (-DI). The +DI measures the strength of the upward trend while the –DI measures the strength of the downward trend. These two measures are also plotted along with the ADX line.
The calculation for the ADX is considerably complex and entails several calculations that go beyond the scope of this tutorial. But, below is the general formulation of the index.
The ADX along with the +DI and –DI are plotted between a bounded range of zero and 100. The standard time period used in this indicator is 14 periods.
Because the ADX is a range-bounded indicator, it gives certain signals when the indicator moves to new levels.
When the ADX is above 40 the trend is considered to have a lot of directional strength either up or down depending on the current direction of the trend. Extreme readings to the upside are considered to be quite rare compared to low readings. When the ADX indicator is below 20 the trend is considered to be weak or non-trending.
The strength in a trend is considered to weaken or strengthen when these lines (40 and 20) are crossed by the ADX. When the ADX has had a strong move above 40 but fails to remain above, it is suggested that the trend is weakening and will reverse. When the ADX moves above 20 it is a sign that a new trend in the security is starting.
It is important to remember that in regard to this trend indicator the ADX does not care about the direction of the trend it only is concerned with the strength of it. When the ADX is high there is strength in a trend. When it is low it signals little to no trending in the security. When there are shifts in the ADX it is a signal of a new trend or trend reversal.
The two measures used to compute the ADX are also used to signal weakening in trends and the starting of new trends. Signals are formed when the two lines, the +D and –D, crossover each other. A buy signal is formed when the +D, which measures the upward trend, crosses above the –D, which measures the downward trend. A sell signal is formed when the –D crosses above the +D. These crossovers signal a shift from an upward trend to a downward trend or visa versa.
This trend indicator is extremely popular and useful as it combines both aspects of trend strength with the ADX and the direction of trends with the +DI/-DI lines. Is another useful indicator for any technical trader.
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