The Average Directional Index (ADX) is a momentum indicator employed by technical traders to identify the strength of a trend in the market. Developed by Welles Wilder, the indicator is derived from the moving average of a defined period. It is read on a scale of 0-100.
ADX trends can go up or down. When its value is above 25, it is considered a bullish signal. Conversely, a value less than 25 is regarded as a negative strength.
The trend strength indicator is accompanied by two other indicators: Positive Directional Indicator (+D) and the Negative Directional Indicator (-D). So, there are a total of three lines. While ADX helps traders identify the strength of a trend, the +D and -D help them identify the direction of the trend. Collectively, these lines enable traders to determine whether to go long or short, or whether to take a position or not.
ADX Indicator Formula: How to Calculate Average Directional Index?
Calculating ADX may seem a bit confusing, but you don’t have to do it manually. You can let any tool do it for you. The mentioned steps below to calculate Average Directional Movement Index is just for your basic understanding:
- Calculate True Range (TR), Positive Directional Movement, and Negative Directional Movement over 14 periods. [+DM = Current High – Previous High] [-DM = Previous Low – Current Low]
- When +DM is higher than -DM, use +DM. When -DM is higher than +DM, use -DM. The True Range equals the greater of current high – current low, current low – previous close, or current high – previous close.
- Smooth 14-period averages of +DM, -DM, and TR.
- Calculate +DI by dividing smoothed +DM value by smoothed TR value and multiplying it by 100.
- Calculate -DI by dividing smoothed -DM value by smoothed TR value and multiplying it by 100.
- Calculate Directional Index by dividing (+DI minus -DI) by (+DI plus -DI) and multiplying it by 100.
- Now calculate ADX by first finding the values of DX for 14 periods. Thereon, smooth the results to get ADX. The first ADX will equal the total of 14 periods DX divided by 14. From there, you can use the formula ((prior ADX * 13) + current DX) / 14 to find ADX.
- Plot ADX, +DI, and -DI values to get Directional Movement Index (DMI).
How to Use ADX Indicator for Trading?
ADX is an excellent indicator that highlights the strength of a trend. (It is considered the best trend indicator by many Forex traders.) The line changes during strong and weak price movements (indicated by the rise and fall of +DI and -DI), hinting traders of the ongoing trend and its strength. Traders can interpret this to identify profitable trends to trade; they can make purchase or sell decisions accordingly.
The ADX value between 0-25 shows the absent or weak trend. The value between 25-50 indicates a strong trend. Between 50-75, it’s a very strong trend, and between 75-100, the trend is extremely strong.
When devising an ADX indicator strategy, traders should also keep an eye on the crossover that can be used to derive trade signals. When DI+ is floating above -DI, it underlines an uptrend, which is a potential signal to buy. And when DI+ is floating below -DI, it underlines a downward trend, which hints at going short. Similarly, when the ADX line clocks consecutive highs, it shows momentum is increasing, and when it marks lower highs, it shows a decreasing trend.
ADX indicator has its limitations though. This is why it’s recommended to use it with price analysis and other indicators as well to get a more concrete understanding and prediction of price movements.
Want to Learn More?
You now know what is an average directional index, ADX indicator formula, and how ADX strategy can help traders. If you want to continue learning, check out our trading guides.
