Average Directional Movement Index, directional system (indicator developed by George. W. Wilder (JW Wilder) in addition to the Parabolic SAR system for measuring the intensity of the market trend; if the ADX is rising, it means that the market tendency becomes stronger, which is favorable condition for entering into transactions, and when ADX falls, it means that the trend in question, in this case the important signals given by the oscillators RSI and Momentum).
The author of this indicator is Welles Wilder, who described it in his book “New Concepts in Technical Trading Systems”.
This method is based on a comparison of the 14 and 14 day -DI-period + DI, or subtracting the second from the first, or by applying indicators to each other. When the + DI above -DI, it is a clear signal to buy, if, on the contrary, lower – something for sale.
The simplest trading method based on the system of directional movement implies comparison of two direction indicators: the 14-period + DI and 14-period -DI. To do this, or charts of indicators one on the other, or + DI is subtracted from -DI. W. Wilder recommends buying when + DI is higher than -DI, and selling when + DI sinks lower than -DI.
These simple trading rules Wells Wilder added “extreme point rule.” It is used to eliminate false signals and decrease the number of deals. The extreme point, when the + DI and -DI should be noted “extreme point.” When the + DI rises above the -DI, the highest price of the day is the intersection. If + DI is lower than -DI, this point – the lowest price of the day crossing.
Extreme point is then used as the entry level market. Thus, after the signal to buy (+ DI rose above the -DI) one must wait till the price rises above the extreme point, and only then buy. If the price fails to rise above the extreme point, you should retain the short position.
To prevent false alarms, the system is supplemented “extreme point rule.” During the + DI and -DI should note the “extreme point.” If -DI below + DI, it will be an extreme point of intersection of the maximum price of the day, if the above – then the minimum. Without these points is difficult to determine the level of entry into the market.
ADX signals on the purchase and sale come from the intersection of the lines + DI and -DI:
+ DI line moves up: When the + DI crosses -DI from the bottom up, it indicates a reversal in the direction of the uptrend and signals the opening position for the purchase and immediate closing positions.
-DI Line moves up: When the line -DI crosses + DI from the bottom up, it indicates a reversal in the direction of the downward trend and signals the opening short positions and the immediate closing of positions on the purchase.
ADX indicator scale
If ADX is between 0 and 25 then the stock is in a trading range. It is likely just chopping around sideways. Avoid these weak, pathetic stocks!
Once ADX gets above 25 then you will begin to see the beginning of a trend. Big moves (up or down) tend to happen when ADX is right around this number.
When the ADX indicator gets above 30 then you are staring at a stock that is in a strong trend! These are the stocks that you want to be trading!
You won’t see very many stocks with the ADX above 50. Once it gets that high, you start to see trends coming to an end and trading ranges developing again.
ADX indicator calculation
ADX = SUM ((+ DI – (-DI)) / (+ DI + (-DI)), N) / N
N – number of periods used in calculation;
SUM (…, N) – the sum for N periods;
+ DI – the indicator value is positive price trends (positive directional index);
-DI – The indicator value is the negative direction of price movements (negative directional index).