The Average Directional Index, or ADX, is a technical indicator designed to measure a trend. It is used to see if there is any movement in the market or in a security, and to measure the strength of any prevailing trend. It is a lagging indicator, meaning that it confirms an uptrend or downtrend after the direction is already established. The ADX will not change until after the market or security has already reversed its trend. Professional traders often combine the ADX with other indicators to surmise how long a trend may last.
Understand how the ADX works. The ADX measures the strength of a prevailing trend using a range from zero to 100. An ADX range from zero to 20 indicates there is no trend or the trend is very weak. A developing trend is indicated by the 20 to 30 range. A strong trend ranges from 30 to 40, a very strong trend from 40 to 60, and an extremely strong trend from 60 to 100. The ADX is non-directional, meaning that a reading of 50 will indicate a very strong bull trend or a very strong bear trend.Step 2
Use your brokerage account screener or free online screener to look for a security with an ADX ranging from 20 to 30, indicating that a trend is just developing. Adding other indicators will help confirm the ADX reading. For example, let’s say that the ADX indicator is reading 25. You add the RSI, Relative Strength Index indicator, which is in an uptrend with a reading below 45. The RSI confirms the ADX indication that the uptrend’s momentum is just starting. Then you add the volume indicator, which is also rising, and further confirms the ADX and RSI bullish indicators.Step 3
Recognize the weaknesses of the ADX indicator. Since the ADX does not tell you if the trend is bullish or bearish, you have to rely on other indicators for that information. The ADX does not give you clear trade exit signals. The reading could be falling because the security is getting ready to make another strong move in the same direction or it could indicate that the trend is falling apart. Because the ADX is a lagging indicator, it can give you false readings. For example, the ADX could indicate a strong trend exists when in reality, the trend has already started to reverse.
- Since the ADX measures trend strength, use other indicators, such as momentum and leading indicators, to confirm the ADX reading.
- When the ADX is above 60, it often indicates that a strong trend is starting to fall apart. Wait until other indicators confirm the trend before opening a trade.
Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.