The Average Directional Movement Index (ADX) is meant to quantify trend strength by measuring the amount of price movement in a single direction. The ADX is a component of the Directional Movement system published by J. Welles Wilder, and is that the average resulting from the Directional Movement indicators.
Period : Number of bars to use within the calculations. the period value within the DM calculation corresponds to trader preference in RSI, Stochastics and other Welles Wilder studies. Daily charts use values of 9 to 14 with 10 being Wilder’s original.
Smoothing Period : Number of bars to use when calculating the smoothed average.
Series : Whether to display the curves.
Shading : Whether to shade the areas between the DI curves when the +DI curve is bigger than the -DI curve. Only valid when Series is enabled.
Histogram : Whether to display the results as a histogram.
Colors : Which colors you prefer for display of graph elements.
Display Axis Label : Whether to display the foremost recent value on the Y axis.
Formula
- Directional Movement (DM) is defined as the largest part of the current period’s price range that lies outside the previous period’s price range.
- PDM = current high minus the previous high (called plus DM)
- MDM = current low minus the previous low (called minus DM)
- If PDM > MDM then MDM is set to zero
- If MDM > PDM then PDM is set to zero
- If current range lies within or is equal to the previous range then set both PDM and MDM to zero
2. Calculate the value of the Plus and Minus Directional Indicators:
Trading within the direction of a robust trend reduces risk and increases profit potential. the typical directional index (ADX) is employed to work out when the price is trending strongly. In many cases, it’s the last word trend indicator. After all, the trend could also be your friend, but it sure helps to understand who your friends are.
ADX is employed to quantify trend strength. ADX calculations are supported a moving average of price range expansion over a given period of time. The default setting is 14 bars, although other time periods are often used. ADX can be used on any trading vehicle like stocks, mutual funds, exchange-traded funds and futures.
ADX is plotted as one line with values starting 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 typically plotted within the same window because the two directional movement indicator (DMI) lines, from which ADX is derived.
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. The chart above is an example of an uptrend reversing to a downtrend. Notice how ADX rose during the uptrend, when +DMI was above -DMI. When price reversed, the -DMI crossed above the +DMI, and ADX rose again to measure the strength of the downtrend.
ADX values help traders identify the strongest and most profitable trends to trade. The values also are important for distinguishing between trending and non-trending conditions. Many traders will use ADX readings above 25 to suggest that the trend is robust enough for trend-trading strategies. Conversely, when ADX is below 25, many will avoid trend-trading strategies.
Low ADX is typically a symbol of accumulation or distribution. When ADX is below 25 for quite 30 bars, price enters range conditions, and price patterns are often easier to spot . Price then moves up and down between resistance and support to seek out selling and buying interest, respectively. From low ADX conditions, price will eventually escape into a trend.
The direction of the ADX line is vital for analyzing trend strength. When the ADX line is rising, trend strength is increasing, and therefore the price moves within the direction of the trend. When the line is falling, trend strength is decreasing, and therefore the price enters a period of retracement or consolidation.
A common misconception is that a falling ADX line means the trend is reversing. A falling ADX line only means the trend strength is weakening, but it always doesn’t mean the trend is reversing, unless there has been a price climax. As long as ADX is above 25, it’s best to consider a falling ADX line as simply less stronger.
The series of ADX peaks also are a visible representation of overall trend momentum. ADX clearly indicates when the trend is gaining or losing momentum. Momentum is that the velocity of price. A series of upper ADX peaks means trend momentum is increasing. A series of lower ADX peaks means trend momentum is decreasing. Any ADX peak above 25 is taken into account strong, albeit it’s a lower peak. In an uptrend, price can still rise on decreasing ADX momentum because overhead supply is devoured because the trend progresses
Knowing when trend momentum is increasing gives the trader confidence to let profits run rather than exiting before the trend has ended. However, a series of lower ADX peaks may be a warning to observe price and manage risk. The simplest trading decisions are made on objective signals, not emotion.
ADX also can show momentum divergence. When price makes a better high and ADX makes a lower high, there’s negative divergence, or non-confirmation. generally , divergence isn’t a sign for a reversal, but rather a warning that trend momentum is changing. it’s going to be appropriate to tighten the stop-loss or take partial profits.
Any time the trend changes character, it’s time to assess and/or manage risk. Divergence can cause trend continuation, consolidation, correction or reversal.
Price is one of the single most vital signal on a chart. Read price first, then read ADX within the context of what price is doing. When you use any indicator, it should add something that price alone cannot easily tell us. for instance , the simplest trends rise out of periods of price range consolidation. Breakouts from a ranges occur when there’s a disagreement between the buyers and sellers on price, which tips the balance of supply and demand. Whether it’s more supply than demand, or more demand than supply, it’s the difference that makes price momentum or you can decides the direction of the move.
Breakouts aren’t hard to identify , but they often fail to progress and you find yourself being a in trap. However, ADX tells you when breakouts are valid by showing when ADX is robust enough for price to trend after the breakout. When ADX rises from below 25 to above 25, price is robust enough to continue in the direction of the breakout.
Conversely, it’s often hard to ascertain when price moves from trend to range conditions. ADX shows when the trend has weakened and is entering a period of range consolidation. Range conditions exist when ADX drops from above 25 to below 25. During a range, the trend is sideways, and there’s general price agreement between the buyers and sellers. ADX will meander sideways under 25 until the balance of supply and demand changes again.
ADX gives great strategy signals when combined with price. First, use ADX to work out whether prices are trending or non-trending, then choose the acceptable trading strategy for the condition. In trending conditions, entries are made on pullbacks and brought within the direction of the trend. In range conditions, trend-trading strategies aren’t appropriate. However, trades are often made on reversals at support (long) and resistance (short).
The best profits come from trading the strongest trends and avoiding range conditions. ADX not only identifies trending conditions, it helps the trader find the strongest trends to trade. The power to quantify trend strength may be a major edge for traders. ADX also identifies range conditions, so a trader won’t grind to a halt trying to trend trade sideways price action. Additionally , it shows when price has broken out of a variety with sufficient strength to use trend-trading strategies. ADX also alerts the trader to changes in trend momentum, so risk management are often addressed. If you would like the trend to be your friend, you’d better not let ADX become a stranger.
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