What Is Average Direction Index (ADX)

Introduction To The Average Directional Index Indicator 

The Average Directional Index is used to identify and measure market strength. With ADX, traders can better read the overall market and evaluate the strength of a trend. The ADX is created by technical analysis J. Welles Wilder, the creator of the Relative Strength Index, the Parabolic SAR, and many others.

How The Average Directional Index Indicator Works

ADX values are especially useful to day traders as it offers insight on whether to short or long an asset. Trading in a clear trend can reduce risks and enhance profit potential. 

ADX calculations are based on a moving average of price range expansion over a given period of time. In the chart, ADX is a single line with values ranging from zero to 100. A reading below 25 indicates that the asset is trading sideways. ADX breaking above 25 suggests that the price is trending. Generally speaking, the higher the ADX reading is, the stronger is the asset trending in one direction. 

How To Calculate The ADX

The ADX indicator combines the Negative Directional Indicator and the Positive Directional Indicator, referring to the +DI and -DI.

The Positive Directional Indicator is used to measure the upward pressure of the price. An upwards +DI suggests an uptrend is gaining in strength.

The Negative Directional Indicator is used to measure the downward pressure of the price. A downwards -DI suggests a downtrend is gaining in strength.

The formula to find +DM and -DM is: 

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

The number of periods must next be selected, but is commonly set to the default of 14 periods. Traders can change the settings on the indicator to suit their unique needs.

To find +DI and -DI, the calculation is as follows:

+DI = 100 times the smoothed moving average of (+DM) divided by the average true range

-DI = 100 times the smoothed moving average of (-DM) divided by the average true range

Finally, the smoothed moving average is calculated over the number of periods selected – at 14 – and the average true range is a smoothed average of the true ranges.

Then we have the complete ADX:

ADX = 100 times the smoothed moving average of the absolute value of (+DI − -DI) divided by (+DI + -DI)

How To Use The ADX

The Average Directional Index is one of the most popular among traders. Here are some tips for taking advantage of the ADX. When the reading of crypto stands above 25 on the ADX indicator, pay close attention to the movement of price. If the crypto is trading upward, usually it signals an uptrend ahead. Otherwise, it suggests that the market is in the short traders’ favor. 

What’s worth noticing is that the ADX can identify when crypto is trading trendless. During this time, it is suggested that traders employ other indicators to view the market or wait patiently for a breakout. 

Conclusion

It’s important to note that the ADX indicator slightly lags behind the price trend, so it should be used in conjunction with other indicators. The Average Directional Index is among the many technical analysis indicators and trading tools available on the Bexplus trading platform.