J. Welles Wilder Jr. developed the Average Directional Index (ADX) to measure trend strength. It is important to detemine whether the market is trending or plaining (moving sideways), for ADX interpretation depends on what a market is doing.
ADX is an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings below 20 indicate trend weakness while high readings above 40 indicate a trend strength. (Given these levels, you can consider the ADX a banded oscillator.) The indicator does not grade a trend as bullish or bearish, but merely assesses a trend's strength. A reading above 40 can indicate a strong downtrend as well as a strong uptrend.
ADX is also useful to identify when a market is abandoning or commencing a trend. When ADX begins to strengthen by crossing from below 20 to above 20, a trading plain may be giving way to a trend. Make it a habit to look for confirmation by other indicators.
ADX is derived from two other indicators, also developed by Wilder, +DI and the -DI. See, Directional Indicator.
An
example of how to construct a Trading
System based on ADX is here
Formulae:
Plus Directional Movement = PDM= H-Hp
Minus Directional Movement = MDM =L - Lp
Where:
H is the highest price of the current period.
Hp is the highest price of the previous period.
L is the lowest price of the current period.
Lp is the lowest price of the previous period.
Cp is the closing price for the previous period.
If |H-Hp| > |L-Lp| then DM is PDM and MDM is zero.
If |H-Hp| < |L-Lp| then DM is MDM and PDM is zero.
TR = True Range = is the largest of H - L; H - Cp; or L - Cp
The four directional movement indicators are:
Plus Directional Movement
PDI = EMA(PDM) / EMA(TR)
Minus Directional Movement
MDI = EMA(MDM) / EMA(TR)
Directional Movement Indicator
DX = (PDI - MDI) / (PDI+ MDI)
Average Directional Movement
ADX = EMA(DX)
Where:
EMA indicates exponentially smoothing.
Parameters:
DXPeriod Period use to calculate the DX
SmoothDXP Period used to smooth the DX
The value of MinBars will be one less than the
number of bars in the candlestick formation
Arguments:
None
Output Indicators:
ADX
Example:
Study Name Expanded in a 3 minute timeframe:
I3_ADX(15,3)_I3
This study calculates ADX with parameters of DXPeriod of 15 and
a SmoothDXP value of 3
The output indicators names are appended to the studyname,
that is if the studyname is sn1 then
the outputindicator is
sn1::ADX
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