Tutorial on Average Directional Index (ADX)

Trading with ADX: Most profitable and least risky strategy is to trade with the Trend. The stronger the trend the better the reward is. Finding the trend, measuring its strength is possible with Average Directional Index (ADX), an indicator developed by Welles Wilder. It may be worth mentioning here that of Welder contribution to technical analysis was also in developing RSI, ATR and Parabolic SAR.

ADX indicator is used to find whether Stock is in trend and also finds the strength of the trend. It, however, does not indicate about the direction of the trend. It provides similar value for both uptrending and down-trending stocks. Stock direction is provided by additional lines that supplement with ADX. We will cover them later.

Though complex in calculating its value, its usage is very simple. Its value oscillates between 0 and 100. Wilder suggested that if ADX is above 25 then stock is trending and as the trend gets stronger, ADX moves up. A value above 40 is considered a very Strong uptrend. A value below 20 is considered as no trend or sideways market.O wing to its vast acceptance, most of technical Analysis software does the calculation including TopStockResearch.

Trading Strategies with ADX and Interpretation

ADX Value	Trend Strength	Comments	Stock Screener at TSR
0-20	Non Trending	Sideways market or a phase of Accumulation/Distribution	Yes
20-25	Trending for less Volatile Stocks	Some Analysts use value above 20 as Trending. Works for lesser volatile stocks	Yes
25-40	Strong Trend	This indicates very strong trend. Traders should take advantage of it.	Yes
40-60	Very Strong Trend	Rare but they do occur	Yes
60-100	Extremely Strong Trend	Very rare. Such trends are not sustainable and traders should be ready for trend reversal	Yes

Although it was developed for commodities, it can be used for stocks also. Since Commodities are more volatile, ADX would yield better results with more volatile stocks. For less volatile stocks, ADX value of above 20 could be considered as trending stocks. Standard period for calculation of ADX is 14 days. Some traders prefer to adjust between 7 to 28 days to suit their needs.

Where ADX line is represented as Green Color and oscillates between 0 and 100. Along with ADX lines, you would see directional Index +DI (Plus Directional Index) and -DI (Minus Directional Index) lines.

ADX is normally represented as a small chart below price chart as

Trending Stocks : ADX works on absolute value. As long as the value is above 25, it is considered as uptrend. Some of the novice trader gets confused when the value falls. Even if ADX falls to above 25 from a higher value, it is considered as trending but it signifies that the trend is weakening and time to get alerted.

Example of Trading Strategies Used With ADX Shown In Axis Bank Chart

Strong Trend: An increase in ADX value of above 25, means that trend is getting stronger and and provides better confidence to the trader.

Divergence: As mentioned earlier, divergence in ADX does not predict fall in price. As long as the value stays above 25, the trend is intact.

Change of Trend : ADX crossing below 25 signifies end of trend or movement in no trade zone.

Non-trending: ADX between 0 to 25 refers to a non trending zone.


Trade with Trailing Stop Loss: Since it indicates about the continuation trend only and not the ultimate target, it can best be traded with trailing stop loss or partial profit booking.

Directional Movement: While ADX provides information only about the strength of the trend, it is normally supplemented with Directional Index +DI and -DI. They indicates direction of the trend. Their interpretation is as follows:
1.When +DI is above -DI then trend is up trend.
2.When -DI is above +DI then trend is downwards.
3.+DI crossing over -DI signals bullish trend and vice versa.

Example of Directional Movement(+DI and -DI) Used With ADX Shown In SBIN Chart

Weakness
1.ADX is based on Moving Averages. Therefore it is slow to react or in other words it is lagging indicator.
2.ADX may not provide signals for slow moving stocks.
3.Crossover of +DI and -DI some times can happen too frequently, thereby giving many false signals.
4.As with other indicators, use ADX when other indicators of your reliance are supporting them.

Example of Too Many Crossover of +DI and -DI as Shown In Boeing Co Chart

Example of Too Many Crossover of +DI and -DI as Shown Axis Bank Chart

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