The Average directional index (ADX) is a tool used by some traders in technical analysis to gauge the strength of a trend in a market.
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It consists of three lines:
The ADX is used to determine whether a trade should be made, and in which direction, based on the strength of the trend. According to its creator, Welles Wilder, a trend is considered strong when the ADX is above 25 and weak or without a clear direction when it is below 20.
Note that a weak trend or a lack of trend doesn't necessarily mean the price is not moving; it could just be in a state of change or too volatile to establish a clear direction.
The Average Directional Index is calculated using the following three components:
The formula for the Positive Directional Indicator (+DI) is:
+DI = 100 * (Positive Directional Movement / Total Directional Movement)
The formula for the Negative Directional Indicator (-DI) is:
-DI = 100 * (Negative Directional Movement / Total Directional Movement)
The formula for the Average Directional Index (ADX) is:
ADX = 100 * (Absolute Value of (+DI - -DI) / (+DI + -DI))
In simple terms, the ADX measures the strength of a trend by comparing the magnitude of positive price movement to negative price movement. A high ADX value indicates a strong trend, while a low ADX value indicates a weak trend or ranging market.
The Average Directional Index (ADX), along with the negative directional indicator (-DI) and positive directional indicator (+DI), is a momentum indicator. The ADX helps traders determine the strength of a trend, while -DI and +DI indicate the direction of the trend.
A strong trend is indicated by the ADX being above 25, and a weak trend is indicated by the ADX being below 20. Crossovers between the -DI and +DI lines can be used to make trading decisions. For instance, if the +DI line goes above the -DI line and the ADX is over 20 or 25, it is a potential signal to buy. Conversely, if the -DI goes above the +DI, and the ADX is over 20 or 25, it could indicate an opportunity to enter a short trade.
Crossovers can also be used to exit trades. For example, if you're in a long trade, you could exit when the -DI crosses above the +DI. When the ADX is below 20, it is signaling that the price is trendless and that it may not be the best time to enter a trade.
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