The Stock Stethoscope

The Average Directional Index (ADX) is a technical indicator used in financial analysis to evaluate the strength of a trend in a security or market. It was developed by J. Welles Wilder Jr. in 1978 and has since become a widely used tool among traders and investors.

The ADX measures the strength of a trend regardless of its direction. It does this by analyzing the difference between two directional indicators: the Positive Directional Indicator (+DI) and the Negative Directional Indicator (-DI). The +DI measures the strength of an uptrend, while the -DI measures the strength of a downtrend.

The ADX is calculated by taking the difference between the +DI and -DI and then smoothing the result with an exponential moving average (EMA). The resulting value is expressed as a percentage and ranges from 0 to 100, with values above 20 indicating a strong trend.

For example, suppose a stock has been in a strong uptrend for several weeks. The +DI would be high, indicating the strength of the trend, while the -DI would be low, indicating a weak downtrend. The ADX value would be high, indicating the strength of the trend regardless of its direction.

Traders and investors use the ADX in a variety of ways. One common strategy is to use the ADX to confirm the presence of a trend before making a trade. For example, a trader might wait for the ADX to cross above 20 before entering a long position in a stock.

Another use of the ADX is to identify when a trend is losing strength. A falling ADX value can signal that a trend is weakening, potentially leading to a reversal. Traders and investors can use this information to exit a position before the trend reverses.

The best settings for the ADX depend on the specific security or market being analyzed. The default setting for the ADX is 14, but traders and investors may adjust this value based on their preferences and trading style. Generally, a shorter ADX period will be more responsive to recent price changes, while a longer period will be more stable and less likely to generate false signals.

In summary, the Average Directional Index (ADX) is a technical indicator that measures the strength of a trend in a security or market. Traders and investors use the ADX to confirm the presence of a trend, identify when a trend is losing strength, and make trading decisions based on this information. The best settings for the ADX depend on the specific security or market being analyzed.