Average Directional Index (ADX) Definition
The Average Directional Index (ADX) is a technical analysis tool used to measure the strength of a trend in financial markets, which was developed by Welles Wilder. It is an oscillator that moves between 0 and 100 and is non-directional, meaning it quantifies trend strength irrespective of its direction. Higher values depict stronger trends, whereas low values indicate weak trends or non-trending conditions.
Average Directional Index (ADX) Key Points
- ADX is used to measure the strength of a trend, not trend direction.
- It ranges between 0 and 100 with typically high values implying a strong trend and low values indicating a weak trend.
- ADX can be used alongside other technical analysis tools to confirm whether the market is trending or not.
- It is a lagging indicator, meaning it is based on past data and may not predict future trends.
What Is the Average Directional Index (ADX)?
The ADX is a tool used in financial market analysis. It is specifically designed to gauge the strength of a trend in a market, independent of its direction. Originally developed by Welles Wilder, the ADX aims to identify whether a market is trending or not, and if so, how strongly.
Why Use the Average Directional Index (ADX)?
Traders and investors use the ADX to confirm the existence and strength of a trend. This is crucial in decision making regarding entering or exiting trades. When the ADX is high, traders expect the existing trend to continue and base their strategies accordingly. Conversely, a low ADX indicates a weak or non-existent trend, suggesting it might be a good time to pursue strategies suited to a range-bound market.
How Does the Average Directional Index (ADX) Work?
ADX is calculated using a sequence of values that include positive directional movement (upward price movement), negative directional movement (downward price movement), and the average true range. These calculations yield two lines: the +DI and -DI. The ADX line is then derived from these. It’s important to note that the ADX is a lagging indicator because it’s based on historical data, meaning it may not accurately predict future trends.
When Is the Average Directional Index (ADX) Used?
The ADX is most commonly used in conjunction with other technical analysis tools to confirm market conditions. High ADX values (typically above 25) are interpreted as an indication of a strong trend while low values (usually below 20) suggest a weak or non-existent trend. Traders often use this information in combination with other indicators to devise a balanced trading strategy.
Who Uses the Average Directional Index (ADX)?
ADX is primarily used by traders and investors who incorporate technical analysis in their trading strategies. It is utilised across different financial markets including stocks, commodities, and cryptocurrencies. Its primary function is to help identify market conditions, namely whether a trend is strong or weak, to support buy or sell decisions.
