The ADX (Average Directional movement Index) Indicator

Discussion in 'Technical Analysis' started by TATrader, Mar 26, 2006.

  1. TATrader

    TATrader Moderator

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    The ADX (Average Directional movement Index) Indicator

    The ADX is part of the direction movement system introduced by J.Welles Wilder in his book New Concepts in Technical Trading Systems. It comprises of the Directional Movement lines the plus DMI line and the minus DMI line and the ADX line (the Average Directional Movement Index)

    ADX.gif

    ADX is created with reference to both positive and negative directional movement and identifying sustained movement in one direction. When this occurs ADX will rise (irrespective of whether the trend is higher or lower). Trend direction is identified by whether positive movement (DMI+) is above or below negative movement (DMI-). Once ADX rises above a certain level a trend can be said to have been established.

    Although the average directional movement index (ADX) isn't used as frequently as some of the popular technical indicators the ADX line has definite advantages because it filters out a lot of the false oscillator signals which are frequently given early in a move.

    A trader can stay with trending positions longer by following the simple guidelines for the ADX line. A climb by the ADX line above 40 followed by a downturn, signals an imminent end to the current trend (whether up or down).

    The ADX is less helpful during sideways markets. During extended consolidation periods the ADX line will slip toward 10. When ADX approaches 10, a major move is usually about to take place. But the ADX line doesn't tell you which direction it will go. You have to rely on other indicators for the probable direction of the next move.

    In short, if the market is trending, the ADX line should be rising. During an extended consolidation period the ADX line will slip toward a low number.

    To sum it up

    • When the ADX starts rising from a low level it signals the beginning of a trend.
    • The trend is confirmed when the ADX has risen above the 20-25 value and the +DMI line has crossed the DMI line (in case of an uptrend)
    • When the ADX has reached an overbought level of 40-50 and starts consolidating or turning down it can signals the end of the current trend.
    • The decline of the ADX signals the consolidation or indecision of the market.
    The optimum use of this indicator would be to consider trades only when the ADX has started to rise from a low level, as it indicates that a sideways basing pattern has been formed and trends usually emerge from extended sideways periods giving highly profitable trades.
     
  2. dmtrader

    dmtrader New Member

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    Greetings,

    glad someone else has looked at Directional Movement - a very good method of quantifying stock price movements in order to infer trending indicators. This concept was developed by Welles Wilder (the same person who pioneered the RSI technical indicator).

    You've got the basics of how to infer up and down trends based on crossovers between the 14-day +DI and the 14-day -DI along with the ADX value. In Wilder's book "New Concepts in Technical Trading Systems", he also insists that the ADXR value be 25 or greater to indicate that the stock is trending. The calculations can be fairly complex and are really tedious if you're trying to track more than a few stocks.

    I have looked at many online sites for the calculations but none provided the details - that's why I ended up buying the Wilder's book. Now there's a free online site that performs these calculations on a daily basis across hundreds of stocks and then flags the trending stocks - http://www.dmtrend.com
     
  3. murthymsr

    murthymsr Well-Known Member

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    hi dmtrader,

    quote:
    The calculations can be fairly complex and are really tedious if you're trying to track more than a few stocks.
    :unquote

    your post and the link provided are very interesting to read.

    If you have the details of calculations for a typical stock to arrive at the indicators, or have any web link or other source which shows such calculations, it will be of great help for me and also other members of this forum.

    I may be able to automate the process of calculations and obtain the selections.

    thanks in advance.
    murthymsr
     
  4. dmtrader

    dmtrader New Member

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    Greetings,

    with regards to the calculations. The site I linked to http://www.dmtrend.com does the calculations daily; there is also now the ability to request a specific stock be added to a list that is used for nightly calculations.

    I have looked online and have not found any adequate instructions on how to perform the calculations. I ended buying Welles Wilder's book "New Concepts in Technical Trading Systems". In this book are all the formulaes and accumulating averaging techinques required to generate the indicators. As I said, the dmTrend site does a good job of doing these calculations for you as well as keep a running history of trending stocks.

    I don't think I can post the formulaes without violating copyright laws - sorry. I purchased the book online via amazon since I could not find a copy locally. I must say, Welles Wilder sure has some very remarkable insights into the analysis of stocks and trading systems. I've read many other books and few have delivered like this book has.
     
  5. murthymsr

    murthymsr Well-Known Member

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    hi dmtrader,

    Thanks for the info.
     
  6. dmtrader

    dmtrader New Member

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    You are welcome - good luck with the search for trading truth. There isn't one singular answer but I believe a simple combination of sound techniques can bring us closer to what we want.

    Here's a very good article by Chuck LeBeau I read a while back where he talks about how most moving averages simply mirror what the market is doing - when the market is doing well, any moving avergae will work! He further states then why he likes Directional Movement -http://www.streetstories.com/lb_futures96.html.

    Good luck.
     

  7. swingtrader

    swingtrader Member

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  8. dmtrader

    dmtrader New Member

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    Yikes, that series of formulas is pretty intimidating isn't it!

    Does anyone have good entry and exit rules using Wilder's ADX analysis? Specifically, I am looking for early detection (with acceptable risk of course) of trends - if you follow Wilder's criteria, you end up way late in getting in.

    Thanks.
     
  9. karthikmarar

    karthikmarar Well-Known Member

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    Let us see what Alexander Elder has to say about this
    Quote
    The single best signal of the Directional System comes after ADX falls below both the directional lines. The longer it stays, the stronger the base for the next move. When ADX rallies from below both the Directional lines, it shows that the market is waking up from a lull. When ADX rises by four steps from its lowest point below both Directional lines it Rings a Bell on a new trend. If the DI+ is on top the trend will be up and DI- is on top the trend will be down.
    Unquote

    Look at Elderpharma chart...the ADX is lying low...also the formation of ascending triangles... all indicate a possible explosive up move...

    Happy Trading

    regards

    Karthik
     
    Last edited: May 20, 2008
  10. dmtrader

    dmtrader New Member

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    Hello Karthik,

    thanks for this detailed reply. I will look into this more closely as the site I maintain generates the detailed ADX indicators (+DI14, -DI14, ADX, ADXR, etc). Can you tell me what trading software or online system you use for ADX analysis? Also, what do you think of the following signals:

    1. a stock's ADX value rises and crosses 20

    2. a stock's ADX shows 3 consecutive increases with the first
    ADX value starting between 16-20.

    I found using Wilder's criteria of ADXR > 25 a little too much of a lagging criteria.

    Thanks again. Hope to hear form you soon.

    ps. the website I maintain is www.dmtrend.com - best wishes.
     
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