What is the Average Directional Index (ADX)deltafx writer 25 December 2021
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The Average Directional Index is one of the most commonly used tools in technical analysis. This indicator aims to help traders find different trends and their strengths. Knowing the direction of a trend helps traders reduce the risk of their trades and maximize their profits. This indicator is made of three separate lines: The Average Directional Index (ADX), the Positive Directional Indicator (+DMI), and The Negative Directional Indicator (-DMI). They help traders decide how to act considering their positions. Calculating ADX can take place using a moving average of a price range expansion in a specific time frame. We will talk about it later in detail.
History of average Directional Index
In 1978 the ADX was created by an engineer named J. Welles Wilder for analyzing price charts. Later he expanded his scope of activities and turned into a technical analyst. He became so good at his job that he managed to create other technical tools such as the Average True Range and Parabolic SAR (Stop and reverse system)
How can the Average Directional Index help traders?
As it was mentioned earlier, the ADX aims to specify the trend and trend strength of an asset on the charts. Although it’s a very effective factor in spotting buying or selling of an asset, it is better to use it in combination with other indicators. The nature of this indicator is lagging. Therefore, this indicator first needs the establishment of trends in order to show the related signals to traders. It also helps you not to fall in the range conditions. Traders must always be aware of the changes in trends because they can easily decrease or wipe their profits out. Keep in mind that when +DI crosses above the -DI, you can begin place positions and place a short position when -DI crosses above +DI.
How to calculate ADX
First, you should identify the negative and positive directional movements. Calculating the up move and down move is necessary for this purpose. “Up move” refers to the current high minus the previous high, and “Down move,” similarly, refers to current low minus the previous low.
When the Up move is bigger than the Down move and zero, the positive directional movement equals the Up move; in other cases, it is zero. But when the Down move is bigger than the Up move, the negative directional movement equals the Down move; in other cases, it is zero. For a given number of periods, the Positive Directional Indicator (+DI) equals 100 times the EMA (exponential moving average) of +DM divided by the ATR (average true range) (usually for 14 days). The Negative Directional indicator (-DI) is calculated by multiplying the EMA of the –DM in 100 and dividing it by the ATR. The EMA of the exact amount of (+DI minus –DI) divided by (+DI plus –DI) equals 100 times the ADX indicator.
What do different values of ADX tell us?
The Average Directional Index goes from 0 to 100, with high values indicating a strong trend and low ones indicating a weak trend. When the value of ADX is above 70, we should know that the related trend is extremely powerful. However, it rarely happens. Again, when the ADX is above 50, it shows us that the trend is very strong. Basically, any ADX value above 40 shows the strength of trends, and the higher it gets, the stronger the trend will be.
The ADX amount between 20 and 40 shows us the confirmation of a trend. When the ADX is above 20, we should be careful about the occurrence of a new trend. And finally, when the ADX is below 20, there is no trend in the market. But it does not mean that the price is not changing. Sometimes the price is extremely volatile, although there is no specific trend in the market.
You can use the average directional index as a part of your strategy in technical analysis to spot the entry and exit points. As always, when it comes to using technical analysis tools, we recommend you not to use any of them alone. Because they can’t always be 100% accurate. Using a combination of some of them is more logical because they can give you better signals and prevent mistakes. Using the average directional index and being aware of the upcoming trends can help you find better trading opportunities.