TECHNICAL ANALYSIS

AVERAGE DIRECTIONAL
INDEX(ADX)

-SACHIN PANDEY (36)

 Average Directional Index (ADX)

J. Welles Wilder developed the Average Directional Index (ADX) to

evaluate the strength of a current trend, be it up or down. It acts
as a guide to confirm the signals produced by other technical
indicators. For example, it can measure whether an uptrend or
downtrend is gaining momentum or slowing down.

• It's important to determine whether the market is trending or

trading (moving sideways), because certain indicators give more
useful results depending on the market doing one or the other.
 The 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 since
such high values indicate a trend that usually
only appears in long bull runs or long recessions.
Usually, any ADX value above 40 is considered to
be a strong trend, while any ADX value below 20
indicates that the stock is in a trading range. The
indicator does not grade the trend as bullish or
bearish, but merely assesses the strength of the
current trend. A reading above 40 can indicate a
strong downtrend as well as a strong uptrend.
 As for signals produced by the Average Directional
Index (ADX) indicator, a move below 40 from
above indicates that the trend is slowing. Since
most option strategies rely on large 
price movements in short timeframes, a slowing
trend is bad. Therefore an ADX move below 40
would indicate that it is time to close our positions.
 Conversely, an ADX indicator move above 20 from
below indicates that the sideways trading is over,
and a new trend is developing. This would indicate
that it is time to make a move, either bullish or
bearish.
 ADX can also be used to identify potential changes in a
market from trending to non-trending. When ADX
begins to strengthen from below 20 and moves above
20, it is a sign that the trading range is ending and a
trend is developing.

 The ADX is derived from two other indicators, also

developed by Wilder, called the
Positive Directional Indicator (sometimes written +DI)
and the Negative Directional Indicator (-DI). The +DI
tracks the upward trend of the stock, while the -DI tracks
the downward trend. The ADX indicator combines the
two and produces a unified trend strength indicator.
 When the ADX Indicator is selected, SharpCharts
plots the Positive Directional Indicator (+DI),
Negative Directional Indicator (-DI)
and Average Directional Index (ADX). With the
Default color scheme on SharpCharts, ADX is the
thick black line with less fluctuation, +DI is green
and -DI is red. +DI measures the force of the up
moves and -DI measures the force of the down
moves over a set period. The default setting is 14
periods, but users are encouraged to modify these
settings according to their personal preferences.
 In its most basic form, signals can be obtained by
looking at where the positive directional index
+DI and negative directional index -DI lines cross
each other. When the +DI crosses above the -DI
from below, it is a bullish signal. When the -DI
crosses above the +DI from below, it is bearish.
 Be careful, though; when a security is in a trading
range, this system may produce many whipsaws.
As with most technical indicators, +DI/-DI crosses
should be used in conjunction with other aspects
of technical analysis.
 The ADX combines +DI with -DI, and then
smooths the data with a moving average to
provide a measurement of trend strength.
Because it uses both +DI and -DI, ADX does not
offer any indication of trend direction, just
strength. Generally, readings above 40 indicate
a strong trend and readings below 20 a weak
trend. To catch a trend in its early stages, you
might look for stocks with ADX that advances
above 20. Conversely, an ADX decline from
above 40 might signal that the current trend is
weakening and a trading range is developing.
 Bear in mind that increasing the number of
periods will smooth the ADX line (making it less
volatile), and display more significant readings.
The readings, however, will present more of a
lag. For example, if charting 30 periods,
readings over 40 become stronger indicators of
a trend. However, the trend may have already
started and could have been caught earlier less
periods were used.