ADX - Measuring the Strength of a Trend

What is ADX

ADX stands for Average Directional Index. It was introduced by J. Welles Wilder in 1978 in his book "New Concepts in Technical Trading Systems." In this same book, Wilder also introduced RSI and Parabolic SAR.

The most important point to understand about ADX is this:

ADX only measures the strength of a trend. It does not indicate the direction of the trend.

This means that a high ADX value does not imply that prices are rising. A high ADX simply indicates that a strong trend is in progress - it cannot tell you whether that trend is bullish or bearish based on ADX alone. Determining direction is the job of +DI and -DI, which are used together with ADX.

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Components of ADX

The ADX system consists of three lines. Together, these three are also known as DMI (Directional Movement Indicator).

+DI (Positive Directional Indicator)

+DI represents the strength of upward movement. It is calculated based on how much the current candle's high exceeds the previous candle's high. A higher +DI value indicates stronger upward momentum.

-DI (Negative Directional Indicator)

-DI represents the strength of downward movement. It is calculated based on how much the current candle's low is below the previous candle's low. A higher -DI value indicates stronger downward momentum.

ADX Line

The ADX line is a smoothed absolute value of the difference between +DI and -DI. The default period is 14 days. It shows trend strength as a value between 0 and 100, regardless of direction.

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How to Read ADX Values

ADX values range from 0 to 100, with the magnitude indicating trend strength.

Generally, when ADX is above 25, a meaningful trend is considered to exist, and when below 20, the market is viewed as ranging without a clear trend. However, these thresholds should be applied flexibly depending on the market and asset.

The Direction of ADX Also Matters

Not only the absolute value of ADX but also whether ADX is rising or falling is important.

• Rising ADX: The trend is strengthening. Movement in the current trend direction is accelerating.
• Falling ADX: The trend is weakening. The current trend may be slowing or transitioning to a ranging market.
• ADX turning down from a peak: The trend may have peaked. This doesn't necessarily mean a trend reversal, but it's a warning that trend momentum is weakening.

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+DI / -DI Crossover Signals

In the ADX system, trading signals primarily come from crossovers between +DI and -DI.

Buy Signal

A buy signal occurs when +DI crosses above -DI from below. This means that upward momentum is beginning to overtake downward momentum. When ADX is above 25 at this time, the signal has higher reliability.

Sell Signal

A sell signal occurs when -DI crosses above +DI from below. This means downward momentum is beginning to overtake upward momentum. Similarly, when ADX is above 25, the signal is more reliable.

Filtering Crossovers

Crossovers between +DI and -DI that occur when ADX is low (during ranging markets) are likely to be false signals. Therefore, it's good to check the following conditions:

1. Did the crossover occur when ADX is above 20?
2. Is ADX rising (is the trend strengthening)?
3. After the crossover, is price moving in the indicated direction?

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Common Mistake: Rising ADX Does Not Mean Rising Prices

The most common mistake traders new to ADX make is confusing rising ADX with rising prices.

To emphasize again, ADX does not indicate direction. If ADX rises from 20 to 50, it simply means "a strong trend is in progress." Whether that trend is bullish or bearish must be confirmed by the positions of +DI and -DI, or by other trend indicators.

If ADX is 50 and -DI is above +DI, this means a strong downtrend is in progress. A high ADX value is not a reason to buy.

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Combining with Other Indicators

The true value of ADX is realized when used with other indicators. Since ADX only indicates trend strength, it can be used to filter signals from other indicators.

ADX + Moving Averages

When a golden cross or death cross occurs on moving averages, if ADX is above 25, the signal can be considered more reliable. Conversely, moving average crossovers when ADX is below 20 are likely false signals in a ranging market.

ADX + MACD

The same applies to MACD crossover signals. Even if a buy signal appears on MACD, if ADX is very low, the trend hasn't developed yet, so the signal's effectiveness is limited. When MACD signals appear simultaneously as ADX rises above 25, it provides strong entry justification.

ADX + Parabolic SAR

Parabolic SAR works well in trending markets but produces frequent false signals in ranging markets. By only following Parabolic SAR signals when ADX is above 25, you can filter out many false signals during ranging periods.

ADX + Oscillators

RSI and Stochastic are indicators that work better in ranging markets. When ADX is below 20 indicating no trend, overbought/oversold signals from these oscillators are more valid. Conversely, during strong trends when ADX is high, oscillators can remain in overbought/oversold territory for extended periods, so caution is needed.

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ADX Strategy Summary

ADX is not an indicator that tells you when to buy or sell by itself, but it's very useful as a filter to determine whether signals from other indicators are valid. This is because it's one of the few indicators that objectively answers the question "Is there a trend right now, or not?"

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Next article: Parabolic SAR - The Dots That Signal Trend Reversals