ADX / Directional Movement Index

The ADX Indicator, otherwise known as Directional Movement Index.

The ADX is a trend following system. The average directional movement index, or ADX, determines the market trend. When used with the up and down directional indicator values, +DI and -DI, the ADX is an exact trading system. The standard interpretation for using the ADX (blue line) is to establish a long position whenever the +DI (green line) crosses above the -DI (red line). You reverse that position, liquidate the long position and establish a short position, when the -DI crosses above the +DI. In addition to the crossover rules, you must also follow the extreme point rule. When a crossover occurs, use the extreme price as the reverse point. For a short position, use the high made during the trading interval of the crossover. Conversely, reverse a long position using the low made during the trading interval of the crossover. You maintain the reverse point, the high or low, as your market entry or exit price even if the +DI and the -DI remain crossed for several trading intervals. This is supposed to keep you from getting whipsawed in the market. For some traders, the most significant use of the ADX is the turning point concept. First, the ADX must be above both DI lines. When the ADX turns lower, the market often reverses the current trend. The ADX serves as a warning for a market about to change direction. The main exception to this rule is a strong bull market during a blow-off stage. The ADX turns lower only to turn higher a few days later. According to the developer of the DMI, you should stop using any trend following system when the ADX is below both DI lines. The market is in a choppy sidewise range with no discernible trend. If you need further explanation, please refer to the author's original work. The book titled New Concepts in Technical Trading Systems by J. Welles Wilder, Jr. explains this indicator and several others.