Average Directional Movement Index

Average Directional Movement Index (ADX)

The Average Directional Movement Index (ADX) is a technical indicator that helps determine if there is a price trend. It was developed by Welles Wilder and described in his book ‘New Concepts in Technical Trading Systems’.

Trading Method

The simplest trading method based on the ADX involves comparing two direction indicators: the 14-period +DI and the 14-period -DI. To do this, one either overlays the charts of the indicators or subtracts +DI from -DI. According to Welles Wilder, buying is recommended when +DI is higher than -DI, and selling is recommended when +DI is lower than -DI.

Points of Extremum

Welles Wilder added a rule of points of extremum to the trading method. This rule is used to eliminate false signals and reduce the number of trades. The point of extremum is the point where +DI and -DI cross each other. If +DI rises higher than -DI, the point of extremum is considered the maximum price of the day when they cross. If +DI is lower than -DI, the point of extremum is considered the minimum price of the day when they cross.

Market Entry Level

The point of extremum is used as the market entry level. After receiving a buy signal (+DI is higher than -DI), one must wait until the price exceeds the point of extremum before buying. However, if the price fails to exceed the level of the point of extremum, one should retain the short position.

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ADX+DI-DI EURUSD · H1

ADX rises above 25 when the uptrend starts, while +DI stays above -DI.

Calculation of ADX

+DM = MAX(HIGH(i) - HIGH(i - 1), 0)
-DM = MAX(LOW(i - 1) - LOW(i), 0)
TR = MAX(HIGH(i) - LOW(i), ABS(HIGH(i) - CLOSE(i - 1)), ABS(LOW(i) - CLOSE(i - 1)))
+DI = EMA(+DM / TR * 100, N)
-DI = EMA(-DM / TR * 100, N)
DX = ABS(+DI - -DI) / (+DI + -DI) * 100
ADX = SMA(DX, N)

Where:

• +DM and -DM are the directional movements: only the larger of the two is kept, the other one is set to 0;
• TR is the True Range;
• N is the indicator period (14 by default).

The indicator has three lines: the main ADX line, +DI and -DI. ADX shows the strength of a trend, not its direction. Values above 25 usually point to a trending market, values below 20 to a market without a clear trend.