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ADX Average Directional Index

The Average Directional Movement Index (ADX) technical analysis indicator describes when a market is trending or not trending. When combined with the DMI+ plus and DMI- minus (see: DMI) the ADX can generate potential buy and sell signals.

However, the main purpose of the ADX is to determine whether a stock, future, or currency pair is trending or is in a trading range. Determining which mode a market is in is helpful because it can guide a trader to which other technical analysis indicators to use.

The chart of the E-mini Russell 2000 Index Futures contract below shows an excellent example of the ADX in action:

ADX technical analysis indicator

ADX Shows Trend Strength

The first concept to remember is that the direction that the ADX moves doesn’t depend upon the direction of the underlying stock. All the ADX shows is the trend strength.

  1. Strong upward trend of stock = Increasing ADX
  2. Strong downward trend = Increasing ADX

As can be referenced from the chart of the E-mini Russell 2000 Index Futures contract above, when the e-mini future was rising in a strong upward trend, the ADX indicator was rising.

When the e-mini futures contract moved into a non-directional consolidation phase, the ADX decreased.

ADX is a Great Complement to Other Technical Indicators

The ADX is so popular because determining whether a stock, commodity, or currency market is trending or not trending can help a trader avoid the pitfalls of some indicators.

Moving Averages

Moving averages and their variants are effective during trending markets; however, during consolidation periods when prices go up and down, but in no direction, moving average indicators have a tendency to give numerous false buy and sell signals that can add up to trading losses. During trending markets, it is suggested to use moving averages, trendlines, and other trend following technical indicators.

Oscillators

Oscillators can be effective in non-trending markets. Buying low and selling high is accomplished quite readily with oscillators in a non-trending market. Unfortunately, during trending markets, oscillators perform quite poorly, often selling short during a bull market run or buying during a bear market downtrend, adding up to large losses. For periods of non-trending, oscillators like Stochastic Fast & Slow, RSI, or Williams %R and other range-bound indicators like Bollinger Bands or Moving Average Envelopes could be used.

The importance of the 20-level and 40-level, along with more examples of the ADX in action, is covered on the next page.

The information above is for informational and entertainment purposes only and does not constitute trading advice or a solicitation to buy or sell any stock, option, future, commodity, or forex product. Past performance is not necessarily an indication of future performance. Trading is inherently risky. OnlineTradingConcepts.com shall not be liable for any special or consequential damages that result from the use of or the inability to use, the materials and information provided by this site. See full disclaimer.

Interpreting the ADX

It is important to re-emphasize that the direction of price doesn’t affect the ADX; it is the strength of the stock, futures, or currency’s trend that matters.

Below, we see the E-mini Russell 2000 Futures contract, but here the e-mini future is in a downtrend, a strong downtrend. Note that the ADX is rising even though the price of the e-mini future is falling.

ADX Average Directional Index

Interpreting the ADX

  • Below 20: Non-trending market.
  • Crosses above 20: Signal that a trend might be emerging; traders might consider initiating buy or sell orders in the direction of the prevailing stock, future, or currency price movement.
  • Between 20 & 40: If ADX is increasing between 20 and 40, then it is considered further confirmation of an emerging trend. Traders might consider buying or shortselling in the direction of the current market direction. Furthermore, traders might avoid using oscillator technical indicators and instead consider using trend following indicators like moving averages.
  • Above 40: Very strong trend.
  • Crosses above 50: Extremely strong trend.
  • Crosses above 70: "Power Trend"; very rare occurence

In his book, New Concepts in Technical Trading Concepts, Welles Wilder, Jr., the creator of the ADX also created the DMI+ and DMI- indicators to generate potential buy and sell signals specifically for the ADX technical analysis indicator. In fact the ADX is derived from the DMI+ and DMI- calculations (see: DMI).

The most recent information on the ADX indicator is chronicled in the book ADXcellence by Dr. Charles B. Schaap.

The information above is for informational and entertainment purposes only and does not constitute trading advice or a solicitation to buy or sell any stock, option, future, commodity, or forex product. Past performance is not necessarily an indication of future performance. Trading is inherently risky. OnlineTradingConcepts.com shall not be liable for any special or consequential damages that result from the use of or the inability to use, the materials and information provided by this site. See full disclaimer.

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