The average directional index (ADX) is a technical indicator used to measure the strength of a trend. It is a non-directional indicator, it only shows the strength of the trend and not which direction the trend is in. So, on charts it is often accompanied by the negative directional indicator (-DI) and the positive directional indicator (+DI) in order to help traders decide whether they should take a long or short position.
Calculating the ADX
The ADX takes the average or mean of the directional movement index over a period of time (usually 14 periods). The directional movement index is calculated by taking the absolute difference between the positive directional indicator (+DI) and the negative directional indicator (-DI) and dividing it by the total absolute sum of the two indicators (+DI & -DI). Then finally multiplying the result by 100.
How to use the ADX
The ADX, the positive directional indicator (+DI) and the negative directional indicator (-DI) are momentum indicators. The ADX tells you trend strength whereas +DI and -DI help determine trend direction.
An ADX above 25 is considered a strong trend and one below 20 is considered a weak trend. Crossovers between the +DI and -DI in conjunction with ADX can be used to generate trade signals. For example if the +DI is above the -DI and the ADX is above 25 this is a strong uptrend and a potential buy signal. And if the -DI is above the +DI and the ADX is above 25 then this is a potential sell signal or a chance to enter a short position.
In contrast if the ADX is below 20 this might mean that the price is trendless and it may not be an ideal time to enter a position.
Limitations of the ADX
The ADX can create false signals with the ADX moving above 25 temporarily followed by quick reversals in price and the ADX. Also with a weak ADX there can be many crossovers of the negative and positive directional indicators creating false and confusing signals.
As with all technical indicators the ADX should be used in conjunction with other indicators and the individual weightings of the indicator should be adjusted with your trading strategy. E.g. You might only want to consider the ADX a strong trend signal above 30 instead of the standard 25 in your trading strategy.