Average directional movement index
The average directional movement index (ADX) was developed in 1978 by J. Welles Wilder as an indicator of trend strength in a series of prices of a financial instrument.[1] ADX has become a widely used indicator for technical analysts, and is provided as a standard in collections of indicators offered by various trading platforms.
[edit] Calculation
The ADX is a combination of two other indicators developed by Wilder, the positive directional indicator (abbreviated +DI) and negative directional indicator (-DI).[2] The ADX combines them and smooths the result with an exponential moving average.
To calculate +DI and −DI, one needs price data consisting of high, low, and closing prices each period (typically each day). One first calculates the directional movement (+DM and −DM):
- 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
After selecting the number of periods (Wilder used 14 days originally), +DI and −DI are:
- +DI = 100 times exponential moving average of +DM divided by average true range
- −DI = 100 times exponential moving average of −DM divided by average true range
The exponential moving average is calculated over the number of periods selected, and the average true range is an exponential average of the true ranges. Then:
- ADX = 100 times the exponential moving average of the absolute value of (+DI − −DI) divided by (+DI + −DI)
Variations of this calculation typically involve using different types of moving averages, such as a weighted moving average or an adaptive moving average.
[edit] Interpretation
The ADX does not indicate trend direction, only trend strength. It is a lagging indicator; that is, a trend must have established itself before the ADX will generate a signal that a trend is under way. ADX will range between 0 and 100. Generally, ADX readings below 20 indicate trend weakness, and readings above 40 indicate trend strength. An extremely strong trend is indicated by readings above 50.
[edit] References
- ^ J. Welles Wilder, Jr. (June 1978). New Concepts in Technical Trading Systems. Greensboro, NC: Trend Research. ISBN 978-0894590276.
- ^ Michael D. Sheimo (1998). Cashing in on the Dow: using Dow theory to trade and determine trends in today's markets. CRC Press. p. 87. ISBN 9780910944069. http://books.google.com/books?id=jDlZNrcs1RkC&pg=PA87.
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