All trend traders are constantly looking for that next profitable market or stock that is in a defined uptrend or downtrend. For those traders, the ADX Indicator (along with the Minus Directional Indicator (-DI) and Plus Directional Indicator (+DI)) is a great tool that can be used to measure and quantify the direction as well as the strength of the current trend.

What Is The ADX Indicator?

The ADX Indicator, also known as the Average Directional Index, was developed by Welles Wilder in 1978 and is used to measure the strength (or momentum) of trending markets. The ADX by itself however can only indicate the strength of the trend, not trend direction.

This is why Wilder added both the Minus Directional Indicator (-DI) and the Plus Directional Indicator (+DI) as a compliment to the ADX. With the addition of these technical indicators, stock market technicians can now determine both the direction of the trend as well as the strength of that trend by looking at one indicator.

ADX Indicator Chart

In the chart above you can see the ADX Indicator (white line inside the red box). The settings for this technical indicator are default set to 14 periods (blue arrow).

It’s not important that you memorize the exact calculation or terms of the ADX Formula but more importantly how to interpret it. For a more detailed understanding and a list of how the Average Directional Indicator and the directional movement indicators are calculated here is a Wikepedia resource for further reading.

ADX Indicator Basics:  Determining The Strength Of The Trend

• Values Range From 0 to 100
• Values 0-25 = Weak or Absent Trend (Non Trending)
• Values 26-50 = Strong Trend
• Values 51-75 = Very Strong Trend
• Values 76-100 = Extremely Strong Trend

Directional Movement Indicator Basics:  Determining The Direction Of The Trend

• +DI > -DI means the buyers have the edge (Bull Market)
• -DI > +DI means the sellers have the edge (Bear Market)

ADX Indicator Trend Technical Analysis

The stock chart below is of Freeport-Mcmoran Copper & Gold (Ticker: FCX) from August of 2010 to around December of 2011. During this time period there were three trends according to the Average Directional Indicator.

Let’s take a look at the three trends indicated first and then bring in the directional movement indicators (dmi).

In the chart above you can see three trending environments indicated by the ADX being greater than a value of 25 (purple line).

The first time the ADX popped above the 25 value line (yellow boxes) it peaked at around 40 before moving down and eventually crossing back below the 25 line and bottoming out at about 20. Remember, crossing down below the 25 value is NOT an indication that the trend has reversed. As illustrated above values of 0-25 indicate a weak or absent trend.

The Average Directional Indicator only spends a few weeks below the 25 line before moving back above this value indicating the second, strong trend (green boxes). In February of 2011 the indicator again drops below the 25 line and stays there for several months.

This multi-month period where the ADX is below 25 also corresponds to a multi-month sideways, or non trending, environment as you can see below.

Following this period, the ADX again rises above the 25 level as price this time starts to downtrend marking the third crossing on this chart.

ADX Indicator with the Plus and Minus Directional Movement Indicators (+DM & -DM)

In the chart above, the middle part of the stock chart where the red and white arrows are is where you can see the Plus Directional Indicators (+DI) and the Minus Directional Indicators (-DI). Remember, while the ADX Indicator indicates trend strength these directional movement indicators show the trend’s direction.

In the first set of green boxes you can see that the ADX is above the 25 line, the +DI (blue line) is above the -DI (green line), and that the stock price is in an uptrend.

The second area indicating on the chart by the orange boxes displays a different set of data. The ADX is above 25 just like in the prior example, however, the -DI (green line) is above the +DI (blue line) indicating that this trend’s direction is down. This is confirmed by looking at the price of the stock.

So, how can you use this indicator to strengthen your Technical Analysis and trading skills?

ADX Indicator Trading Strategies

The following is a really simple trend following system that Wilder himself constructed when he developed this technical indicator.

The strategy uses both the ADX Indicator to confirm the presence of a strong trend (> 25) and then watching for a crossover of the directional movement indicators in the direction of the trend as an entry signal.

Bullish Entry Into ADX Strategy

As you can see the ADX is above 25 indicating a strong trend. Now, the entry into this trend is signaled by the crossover of the +DI (green line) above the -DI (blue line) at the close indicated by the red arrow in the stock chart above.

Bearish Entry Into ADX Stategy

Just like the bullish entry criteria the ADX Value has to be above 25 which signals the presence of a strong market trend. Then, when the -DI (blue line) crosses above the +DI indicated by the red arrow in the stock chart above this is the entry signal into a bearish trade. Remember, anytime the +DI is less than the -DI this indicates that trend is down.

Exit Strategies

There are multiple ways you can use this indicator to locate exits for your trades. However, you must be responsible for your own exit techniques when it concerns how you will exit any and all of your trades. The examples above are just to give you an idea of how anyone can use the ADX Indicator to strengthen their technical trading and is not meant to be a complete trading plan.

The Key Point As Always When Trading Is To…

Plan Your Trade And Trade Your Plan

 

Pro’s and Con’s of The ADX Indicator:

• Pro’s
  • Indicates Trend Strength
  • Indicates Trend Direction (with use of directional indicators)
  • Can be used as a filter to find trending stocks
• Con’s
  • Lagging Indicator

Overall the ADX Indicator is a very powerful Technical Analysis Tool for any trader looking to capitalize in the stock market by using technical indicators during any type of market condition. The strength of this technical indicator lies with it’s ability to help traders identify demand and quantify the direction and strength of market trends.