ADX Indicator
In his well known book “New Concepts in Technical Trading System” Walles Wilder has introduced a set of directional indicators; one of them the ADX (Average Directional moving Index) indicator.
The ADX is a momentum indicator that tries to measure the strength of the trend in attempt to determine is the market trend or it’s in sideway movement.
The ADX based on comparison of another two directional indicators developed by Wilder; Positive Directional Indicator (+DI) and the Negative Directional Indicator (-DI) to produce ADX as showed in the following formula:
ADX = SUM[(+DI-(-DI))/(+DI+(-DI)), N]/N
Where:
N: The period of calculation.
The formula above produces the ADX line which oscillates between the 0-100 values.
And in the same window the +DI and -DI are plotted (Figure 1).
In figure 1 the ADX line is the solid Green line, the +DI is the doted Red line and the -DI is the doted Blue line.
How to trade using ADX indicator?
The first point you have to know about the ADX it’s not a bulish/bearish signals genrator. By other mean it cannot be used alone to determine when to enter the market but it have to be used with another trend follower indicator (e.i. moving average and MACD indicators).
The ADX indicator indicates the strength of the trend without telling you the direction of the trend (upward or downward).
Although the ADX fluctuates from 0 to 100 it’s rarely to score values above 6o. You can use the reading of the ADX with you trend trading as the following:
1- Readings above 40 indicate the strength of the trend. The same when the ADX moves below 40 to above 40 a trend strength is excepted.
You can use the crossing of +DI and -DI to determine the trend direction; when +DI crosses -DI upward it’s a bulish signal. Conversely, when +DI crosses -DI downward it’s a bearish signal. You can to return to your trend follower indicator to decide where to go.
2- Readings below 20 indicate ranged trend and flat period. similarly when the ADX moves from 40 or above downward to 20. You can dicide to close your trend follower position or tighten your stop loss.
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