Average directional movement index

Last updated

The average directional movement index (ADX) was developed in 1978 by J. Welles Wilder as an indicator of trend strength in a series of prices of a financial instrument. [1] ADX has become a widely used indicator for technical analysts, and is provided as a standard in collections of indicators offered by various trading platforms.

Contents

Calculations

The ADX is a combination of two other indicators developed by Wilder, the positive directional indicator (abbreviated +DI) and negative directional indicator (-DI). [2] The ADX combines them and smooths the result with a smoothed moving average.

To calculate +DI and -DI, one needs price data consisting of high, low, and closing prices each period (typically each day). One first calculates the directional movement (+DM and -DM):

UpMove = today's high − yesterday's high
DownMove = yesterday's low − today's low
if UpMove > DownMove and UpMove > 0, then +DM = UpMove, else +DM = 0
if DownMove > UpMove and DownMove > 0, then -DM = DownMove, else -DM = 0

After selecting the number of periods (Wilder used 14 days originally), +DI and -DI are:

+DI = 100 times the smoothed moving average of (+DM) divided by average true range
-DI = 100 times the smoothed moving average of (-DM) divided by average true range

The smoothed moving average is calculated over the number of periods selected, and the average true range is a smoothed average of the true ranges. Then:

ADX = 100 times the smoothed moving average of the absolute value of (+DI − -DI) divided by (+DI + -DI)

Variations of this calculation typically involve using different types of moving averages, such as an exponential moving average, a weighted moving average or an adaptive moving average. [3]

Interpretation

The ADX does not indicate trend direction or momentum, only trend strength. [4] It is a lagging indicator; that is, a trend must have established itself before the ADX will generate a signal that a trend is under way. ADX will range between 0 and 100. Generally, ADX readings below 20 indicate trend weakness, and readings above 40 indicate trend strength. An extremely strong trend is indicated by readings above 50. Alternative interpretations have also been proposed and accepted among technical analysts. For example it has been shown how ADX is a reliable coincident indicator of classical chart pattern development, whereby ADX readings below 20 occur just prior to pattern breakouts. [5] The value of the ADX is proportional to the slope of the trend. The slope of the ADX line is proportional to the acceleration of the price movement (changing trend slope). If the trend is a constant slope then the ADX value tends to flatten out. [6]

Timing

Various market timing methods have been devised using ADX. One of these methods is discussed by Alexander Elder in his book Trading for a Living. One of the best buy signals is when ADX turns up when below both Directional Lines and +DI is above -DI. You would sell when ADX turns back down. [7]

Related Research Articles

In finance, technical analysis is an analysis methodology for analysing and forecasting the direction of prices through the study of past market data, primarily price and volume. As a type of active management, it stands in contradiction to much of modern portfolio theory. The efficacy of technical analysis is disputed by the efficient-market hypothesis, which states that stock market prices are essentially unpredictable, and research on whether technical analysis offers any benefit has produced mixed results. It is distinguished from fundamental analysis, which considers a company's financial statements, health, and the overall state of the market and economy.

The relative strength index (RSI) is a technical indicator used in the analysis of financial markets. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading period. The indicator should not be confused with relative strength.

In stock and securities market technical analysis, parabolic SAR is a method devised by J. Welles Wilder Jr., to find potential reversals in the market price direction of traded goods such as securities or currency exchanges such as forex. It is a trend-following (lagging) indicator and may be used to set a trailing stop loss or determine entry or exit points based on prices tending to stay within a parabolic curve during a strong trend.

<span class="mw-page-title-main">MACD</span> Chart indicator of moving average convergence/divergence

MACD, short for moving average convergence/divergence, is a trading indicator used in technical analysis of securities prices, created by Gerald Appel in the late 1970s. It is designed to reveal changes in the strength, direction, momentum, and duration of a trend in a stock's price.

<span class="mw-page-title-main">Bollinger Bands</span> Statistical price volatility chart

Bollinger Bands are a type of statistical chart characterizing the prices and volatility over time of a financial instrument or commodity, using a formulaic method propounded by John Bollinger in the 1980s. Financial traders employ these charts as a methodical tool to inform trading decisions, control automated trading systems, or as a component of technical analysis. Bollinger Bands display a graphical band and volatility in one two-dimensional chart.

<span class="mw-page-title-main">Trix (technical analysis)</span>

Trix is a technical analysis oscillator developed in the 1980s by Jack Hutson, editor of Technical Analysis of Stocks and Commodities magazine. It shows the slope of a triple-smoothed exponential moving average. The name Trix is from "triple exponential."

The commodity channel index (CCI) is an oscillator indicator that is used by traders and investors to help identify price reversals, price extremes and trend strength when using technical analysis to analyse financial markets.

Average true range (ATR) is a technical analysis volatility indicator originally developed by J. Welles Wilder, Jr. for commodities. The indicator does not provide an indication of price trend, simply the degree of price volatility. The average true range is an N-period smoothed moving average (SMMA) of the true range values. Wilder recommended a 14-period smoothing.

Ease of movement (EMV) is an indicator used in technical analysis to relate an asset's price change to its volume. Ease of Movement was developed by Richard W. Arms, Jr. and highlights the relationship between volume and price changes and is particularly useful for assessing the strength of a trend. High positive values indicate the price is increasing on low volume: strong negative values indicate the price is dropping on low volume. The moving average of the indicator can be added to act as a trigger line, which is similar to other indicators like the MACD.

The Negative Volume Index and Positive Volume Index are indicators to identify primary market trends and reversals when using technical analysis to study financial markets.

The mass index is an indicator, developed by Donald Dorsey, used in technical analysis to predict trend reversals. It is based on the notion that there is a tendency for reversal when the price range widens, and therefore compares previous trading ranges.

<span class="mw-page-title-main">Pivot point (technical analysis)</span>

In financial markets, a pivot point is a price level that is used by traders as a possible indicator of market movement. A pivot point is calculated as an average of significant prices from the performance of a market in the prior trading period. If the market in the following period trades above the pivot point it is usually evaluated as a bullish sentiment, whereas trading below the pivot point is seen as bearish.

Stochastic oscillator is a momentum indicator within technical analysis that uses support and resistance levels as an oscillator. George Lane developed this indicator in the late 1950s. The term stochastic refers to the point of a current price in relation to its price range over a period of time. This method attempts to predict price turning points by comparing the closing price of a security to its price range.

<span class="mw-page-title-main">Moving average crossover</span>

In the statistics of time series, and in particular the stock market technical analysis, a moving-average crossover occurs when, on plotting two moving averages each based on different degrees of smoothing, the traces of these moving averages cross. It does not predict future direction but shows trends. This indicator uses two moving averages, a slower moving average and a faster moving average. The faster moving average is a short term moving average. For end-of-day stock markets, for example, it may be 5-, 10- or 25-day period while the slower moving average is medium or long term moving average. A short term moving average is faster because it only considers prices over short period of time and is thus more reactive to daily price changes. On the other hand, a long term moving average is deemed slower as it encapsulates prices over a longer period and is more lethargic. However, it tends to smooth out price noises which are often reflected in short term moving averages.

On the technical analysis chart, a wedge pattern is a market trend commonly found in traded assets. The pattern is characterized by a contracting range in prices coupled with an upward trend in prices or a downward trend in prices.

The Vortex Indicator is a technical indicator invented by Etienne Botes and Douglas Siepman to identify the start of a new trend or the continuation of an existing trend within financial markets. It was published in the January 2010 edition of Technical Analysis of Stocks & Commodities.

<span class="mw-page-title-main">Ichimoku Kinkō Hyō</span>

Ichimoku Kinko Hyo (IKH) (Japanese: 一目均衡表, Hepburn: Ichimoku Kinkō Hyō), usually shortened to "Ichimoku", is a technical analysis method that builds on candlestick charting to improve the accuracy of forecast price moves.

In financial technical analysis, the know sure thing (KST) oscillator is a complex, smoothed price velocity indicator developed by Martin J. Pring.

The true strength index (TSI) is a technical indicator used in the analysis of financial markets that attempts to show both trend direction and overbought/oversold conditions. It was first published William Blau in 1991. The indicator uses moving averages of the underlying momentum of a financial instrument. Momentum is considered a leading indicator of price movements, and a moving average characteristically lags behind price. The TSI combines these characteristics to create an indication of price and direction more in sync with market turns than either momentum or moving average. The TSI is provided as part of the standard collection of indicators offered by various trading platforms.

Heikin-Ashi is a Japanese trading indicator and financial chart that means "average bar". Heikin-Ashi charts resemble candlestick charts, but have a smoother appearance as they track a range of price movements, rather than tracking every price movement as with candlesticks. Heikin-Ashi was created in the 1700s by Munehisa Homma, who also created the candlestick chart. These charts are used by traders and investors to help determine and predict price movements.

References

  1. ↑ J. Welles Wilder, Jr. (June 1978). New Concepts in Technical Trading Systems . Greensboro, NC: Trend Research. ISBN   978-0894590276.
  2. ↑ Michael D. Sheimo (1998). Cashing in on the Dow: using Dow theory to trade and determine trends in today's markets. CRC Press. p. 87. ISBN   978-0-910944-06-9.
  3. ↑ Do Adaptive Moving Averages Lead To Better Results? By Michael Carr
  4. ↑ Newsome, Jerremy (2013-07-25). "One of my favorite technical indicators…". Trade Smart University. Archived from the original on 2013-07-27. Retrieved 2013-07-31.
  5. ↑ Chesler, Daniel (Winter 2000). "Volatility and Structure: Building Blocks of Classical Chart Pattern Analysis". Market Technicians Association. Archived from the original on 2014-06-20.
  6. ↑ "How to use ADX/DMS indicator - Technical indicator". SAR Publisher. 2019-02-23. Retrieved 2019-02-25.
  7. ↑ Alexander Elder (Winter 1993). Trading for a Living . John Wiley & Sons. p.  141. ISBN   0471592242. adx.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.