Average Direction Index(ADX): How to use Average Direction Index indicator to analyze the market

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Was developed by Welles Wilder.

The average directional index is a technical analysis indicator used by some traders to determine the strength of a trend. The trend can either be an up or a down trend shown by two accompanying indicators,that is ;

 

-The Negative Directional indicator(-DI)

-The positive Directional indicator(+DI)

 

The ADX is calculated using the following formula;

 

+DI = Smoothed + DM  *   100

                  ATR

WHILE;

 

-DI = Smoothed - DM  *100

                    ATR

DX= +DI - - DI    /     +DI + - DI 

THEREFORE;

 

ADX = (prior ADX * 13) + current ADX

                                        14

 

Where as;

 

+DM = Current high - previous high

 

-DM = Current low - previous low

 

smoothed+/-DM = sum 14 period of DM - (Sum of 14 period of DM/14) + CURRENT DM

 

 

 

ADX normally ranges between 0 to 100 .When the reading of ADX is below 20,that is an indication of a weak trend market while when the ADX reading is above 50,that is an indication of a strong  trend market.

 

Unlike stochastic and RSI,ADX does not indicate whether the trend of the market is bear or bullish.Instead,it only measures the strength of the current market trend.Because of this,the ADX is used to identify whether the market is ranging or it is starting a new trend.

Therefore,when the ADX has a stronger trend,it will result to a larger reading no matter whether the trend of the market is an upward or a downward trend.

 

The ADX constitute of 3 lines in a candle stick chart,that is;

 

-The ADX itself

- The +DI

-The -DI

When the +DI crosses above -DI while ADX  is above 20 or 25 then the trend will be considered to be an upward thus one should enter a buy position while when the +DI crosses below - DI while the ADX is above  20  or 25 then one should exit the buy position and re-enter the sell position since the trend will be a downward

This is indicated from the candle stick chart below;

 

MetaTrader%2BWeb%2BTerminal%2B%25282%2529.png

From the candle stick chart above,the 3 constitutes lines of ADX are represented by the red arrows.

The plus and minus directional index are crossing each other thus giving the trader the trading signal of the trend direction.For the case where the plus directional index is crossing above the minus directional index,that is a signal of an upward trend thus the trader should enter a buy position.For the case where the minus directional index is crossing above the plus index,then that is an indication of a signal of a downward trend thus the trader should close the buy position and enter the sell position.

 

Recommendation: If you are a day trader,just use 1min,5min,15min or 30min time frame while if you are a swing trader just use 1hr and above timeframe if you want the ADX indicator to work for you well.

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quintomudigo
quintomudigo

Trader, Blockchain Technologist and Contentpreneur. Also founder and CEO @ Teacher Forex School.


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