Read on to find out about the Average Directional Movement Index (ADX), a technical analysis tool used to determine trend strength.
We explain just how the ADX presents trend strengths and how you can read the ADX indicators on a chart.
See our example chart below with a detailed explanation of ADX interpretations.
Contents
What Is The Average Directional Movement Index?
The Average Directional Movement Index technical analysis indicator describes when a market is trending or not trending.
When combined with the DMI+ plus and DMI– minus the ADX can generate potential buy and sell signals.
However, the main purpose of the ADX is to determine whether a stock, future or currency pair is trending or is in a trading range.
Determining which mode a market is in is helpful because it can guide a trader to which other technical analysis indicators to use.
ADX Shows Trend Strength
The first concept to remember is that the direction that the ADX moves don’t depend upon the direction of the underlying stock.
All the ADX shows is the trend strength.
- Strong upward trend = Increasing ADX
- Strong downward trend = Increasing ADX
As can be referenced from the chart of the E-mini Russell 2000 Index Futures contract above, when the e-mini future was rising in a strong upward trend, the ADX indicator was rising.
When the e-mini futures contract moved into a non-directional consolidation phase, the ADX decreased.
ADX is a Great Complement to Other Technical Indicators
The ADX is so popular because determining whether a stock, commodity or currency market is trending or not trending can help a trader avoid the pitfalls of some indicators.
Moving Averages For Trending Markets
Moving averages and their variants are effective during trending markets.
However, during consolidation periods when prices fluctuate up and down, moving average indicators have a tendency to give numerous false buy and sell signals that can add up to trading losses.
During trending markets, it is suggested to use moving averages, trendlines, and other trends following technical indicators.
Oscillators For Non-Trending Markets
Oscillators can be effective in non-trending markets. Buying low and selling high is accomplished quite readily with oscillators in a non-trending market.
Unfortunately, during trending markets, oscillators perform quite poorly, often selling short during a bull market run or buying during a bear market downtrend, adding up to large losses.
For periods of non-trending, oscillators like Stochastic Fast & Slow, RSI, or Williams %R and other range-bound indicators like Bollinger Bands or Moving Average Envelopes could be used.
The importance of the 20-level and 40-level, along with more examples of the ADX in action, is covered on the next page.
How To Interpret The ADX
It is important to re-emphasize that the direction of price doesn’t affect the ADX; it is the strength of the stock, futures, or currency’s trend that matters.
Below, we see the E-mini Russell 2000 Futures contract, but here the e-mini future is in a downtrend, a strong downtrend. Note that the ADX is rising even though the price of the e-mini future is falling.
ADX Interpretations Explained
- Below 20: Non-trending market.
- Crosses above 20: Signal that a trend might be emerging; traders might consider initiating buy or sell orders in the direction of the prevailing stock, future, or currency price movement.
- Between 20 & 40: If ADX is increasing between 20 and 40, then it is considered a further confirmation of an emerging trend. Traders might consider buying or short selling in the direction of the current market direction. Furthermore, traders might avoid using oscillator technical indicators and instead consider using trend following indicators like moving averages.
- Above 40: Very strong trend.
- Crosses above 50: Extremely strong trend.
- Crosses above 70: “Power Trend”; very rare occurrence
In his book, New Concepts in Technical Trading Concepts, Welles Wilder, Jr., the creator of the ADX also created the DMI+ and DMI- indicators to generate potential buy and sell signals specifically for the ADX technical analysis indicator.
In fact the ADX is derived from the DMI+ and DMI– calculations.
The most recent information on the ADX indicator is chronicled in the book ADXcellence by Dr. Charles B. Schaap.
Where To Practice The ADX Index During Trading
If you are interested in trading stocks & commodities using technical analysis, have a look at our reviews of these regulated brokers available in to learn which charting & analysis tools they offer:
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74%-89% of retail investor accounts lose money when trading CFDs. You should consider whether you can afford to take the high risk of losing your money.
Further Reading
If you’d like to know about different ways and brokers where you can trade and utilize your knowledge of ADX indices, see our guides on:
You can learn about other technical indicators and analysis strategies, including:
