The Average Directional Movement Index: How to Measure Trend Strength Market Pulse

Average Directional Index

Also, this article will analyze practical examples of opening trades with screenshots and ADX trading strategies. The best ADX indicator settings depend on how you plan on using the tool. It is fairly customisable – you can change the smoothed moving average to a different number of sessions, or change it to a different moving average entirely. The ADX can also provide a bit of extra confidence to let profits run when trend trading.

  • The point that the arrow points to is where the +DI and -DI lines swapped.
  • The signal remains in force as long as this low holds, even if +DI crosses back below -DI.
  • In trading, market participants use two contrasting types of analysis.
  • This determination helps traders choose between a trend-following system or a non-trend-following system.
  • The best trades come from trading the strongest trends and avoiding range conditions.

It is respresented in the image below by the blue line on the lower chart. The red arrow on the chart indicates the point of opening the trade. The situation indicated in Average Directional Index point 1 was explained at the beginning of this section. The index left the 0-20 zone after the +DI and -DI crossover, the red dotted -DI went up, indicating a downtrend.

Directional Movement Indicator (DMI) and Average Directional Index (ADX)

Volume-based indicators, basic trend analysis and chart patterns can help distinguish strong crossover signals from weak crossover signals. For example, chartists can focus on +DI buy signals when the bigger trend is up and -DI sell signals when the bigger trend is down. The trend can be either up or down, and this is shown by two accompanying indicators, the negative directional indicator (-DI) and the positive directional indicator (+DI). These are used to help assess whether a trade should be taken long or short, or if a trade should be taken at all. In the circled section of the chart below, the ADX, +DI, and -DI reveal a strong downtrend, but the trend strength diminishes and the price rebounds after this juncture.

Average Directional Index

Created by Welles Wilder (also creator of RSI); DMI measures the “directional movement”, using today’s high and low prices relative to the previous day’s high and low prices. By smoothing these comparisons over time, DMI uses the theroy that an uptrend sees higher highs, and a downtrend sees lower lows. The stochastic oscillator and MACD are already a popular pairing because of their complementary roles in analyzing trade opportunities. Finally, the ADX offers the inescapable limitation of being a lagging indicator, which means traders are always operating off past data to understand potential price movement. Consequently, there’s always a risk that the indications offered by the ADX will mislead traders into making trades that result in a net loss.

Rules and Tips for Using the ADX Indicator

Nonetheless, a cross down through 40 only means a trend is weakening. There is still likely enough momentum behind the shares for a trend to continue further. Likewise, a cross up through 20 only suggests the trend is strengthening. It will probably need to keep moving in this direction a while longer for it to graduate to a classification of ‘strong’. The ADX or Average Directional Index gauges the strength of a share’s current trend, whether shares are rising, falling, or moving sideways. It is helpful for identifying whether a trend is in place or not, as certain indicators work best when one is present.

The stock market can be immensely volatile, and share prices are often influenced by fundamental factors and economic events such as news reports and performance documents. Subsequently, having an effect on a stock’s price in a rapid timeframe, making it more difficult to use technical analysis tools to predict share value direction. For this reason, the ADX indicator and other trend-based indicators do not work as well for the share market as for other financial instruments.

Pairing the ADX with Other Tools

A decline in the indicator usually alerts traders to a change in the price direction. So, if a trader considers medium-term trading, it’s an opportunity to exit the market with the largest potential profit in case of a successful trade. If a trader considers longer-term trading in a solid uptrend, they can use ADX to partially close trades. Every time the indicator sets a new peak and decline, the trader can close a trade.

Leave a Comment