Average Directional Index
AVERAGE DIRECTIONAL INDEX (ADX)
an indicator of trend strength
J. Welles Wilder created the Average Directional Index in 1978 as an indicator of trend strength in a series of prices of a financial instrument. ADX has been used widely as an indicator by technical analysts. It is provided as a standard in collections of indicators offered by many trading platforms.
How to Compute for ADX
The ADX is a combination of two other indicators designed by Wilder, namely, the positive directional indicator (abbreviated +DI) and the negative directional indicator (-DI). The ADX combines them and smooths the result with an exponential moving average (EMA).
In calculating +DI and -DI, one needs to have the price data which consist of High, Low, and Closing prices each period, typically of each day. One first calculates the Directional Movement (+DM and -DM):
UpMove = Today’s High − Yesterday’s High
DownMove = Yesterday’s Low − Today’s Low
if UpMove > DownMove and UpMove > 0, then +DM = UpMove, else +DM = 0
if DownMove > UpMove and DownMove > 0, then -DM = DownMove, else -DM = 0
After selecting the number of periods (Wilder used 14 days originally), +DI and -DI are:
+DI = exponential moving average of +DM divided by Average True Range
-DI = exponential moving average of -DM divided by Average True Range
The EMA is calculated over the number of periods selected, and the average true range is an exponential average of the true ranges. Then:
ADX = 100 times the exponential moving average of the Absolute value of (+DI − -DI) divided by (+DI + -DI)
Notes:
1. Variations in the calculations usually result in the use of different types of moving averages (like weighted moving average or adaptive moving average).
2. The ADX does not indicate trend direction, only trend strength.
3. It is a lagging indicator; that is, a trend must have established itself before the ADX will generate a signal that a trend is underway.
4. ADX will range between 0 and 100. Generally, ADX readings below 20 indicate trend weakness, and readings above 40 indicate trend strength.