ADX – Average Directional Index.
Developed by J Welles Wilder, Jr., also known for creating one of the most popular indicators, the Relative Strength Index or RSI.
ADX is a non-directional indicator, which means that it doesn’t tell you which direction the security will move, neither up nor down, but calculates the strength of the trend. ADX can be used for stocks, indices, forex and even commodities.
The ADX calculation is based on a 14-period moving average (which can be adjusted). The calculation is a bit complex, but the good thing is that all charting platforms have this indicator – so you don’t have to calculate it manually. Simply select ADX from the indicator list dropdown in your charting platform and you are good to go.
In case you’re still curious about the formula, here it is:
ADX = MA [((+DI) – (-DI)) / ((+DI) + (-DI))] ×100;
+ DI is the difference between today’s high and yesterday’s high
-DI is the difference between today’s lowest price and yesterday’s lowest price
Note: When using the weekly chart, the DI is the difference between the current week and the high and low of the previous week.
Let’s get straight to the understanding of the indicator – the value shows whether the stock is trending or not.
The values are grouped into a range that shows the strength of the trend.
ADX value trend
-0-25: Trend is weak
-25-50: Strong trend
-50-75: Very strong
Easy, isn’t it? So the next time you see a stock with an ADX reading of less than 26, chances are the stock is trying your patience and can keep you restless. While values in the 25-50 range represent a strong trend.
50-75 represents the stock is in a very strong trend. Likewise, the range between 75-100 reflects that the trend is excellent.
Things to note:
ADX is a non-directional indicator, which means you need to use it with other tools and studies, like price action or other indicators used to predict price action.
Use multiple timeframes to get a better sense of trends, e.g. For example, a stock may be trending on the daily chart, but the weekly chart might tell a different story. Like other indicators, ADX has limitations, and it can also have false signals and whiplashes. It’s better to draw a horizontal line at coordinate ’26’.’
While a stock may continue to trend or remain sideways, ADX has limitations in detecting trend reversals.
Rakesh Bansal is a Technical Analyst and Founder of IamRakeshBansal.com