The Average Directional Index (ADX) is a specific indicator used by technical analysts and traders in order to determine the strength of a trend. The trend can be going either up or down, which is shown by two indicators which often accompany ADX, the Positive Directional Indicator, commonly known as +DI, and the Negative Directional Indicator, also known as -DI. It is for this reason that the average directional index is presented with three separate lines, symbolizing each indicator. Each line is used to help assess a trade and whether or not it should taken long or short, if at all.
The Average Directional Index was initially designed by Welles Wilder for commodity daily charts, but was then modified so that it could be used in other markets and for various timeframes. These modifications allowed for ADX to become what it is today - an indicator to track the strength of market trends and analyzing said trends with the aid of additional, directional indicators.
Due to the fact that the Average Directional Index includes multiple lines, the indicator requires a sequence of calculations, which are laid out below.
The Average Directional Index (ADX), as well as the Negative (-DI) / Positive (+DI) Directional Indicators, are momentum indicators and help investors determine the strength of a trend and trend direction..
The Average Directional Index projects market price and it is clearly seen when prices move up (when +DI is above -DI), and when the prices move down (when -DI is above +DI). When there are crosses between both +DI and -DI lines, it can signify potential trading signals, as a bearish or bullish market emerges.
A trend shows the most strength when the Average Directional Index is above 25 (potential signal to buy), and a trend is weak or the price is considered trendless if the ADX reaches below 20 - according to the concept creator, Wilder. Keep in mind, if ADX is below 20, it might not be the most ideal time to enter a trade.
If the market presents itself as not following a specific trend, this does not mean that the price isn’t moving, rather that it could be making a change or the direction is not currently present.
Crossovers between indicator lines can occur quite often. In the case that this occurs too frequently, there will most likely be confusion among traders and the potential for money loss can be high. These moments in question are known as “false signals” and are most common when ADX is calculated below 25.
The Average Directional Index should be combined with other indicators that examine price and others that can help filter signals and control risk to get the most out of the tool. Like most indicators, it works best when paired with highly functioning data processors and other analytical tools.
To sum up, the Average Directional Index is a great tool for technical analysis and determining the strength of a trend, whether it be going up or down. Pair it with other indicators to analyze trends and find when it is a good time to place a trade, given market status.