What is the Directional Movement Index DMI formula and how is it calculated?

adx indicator formula

The Average Directional Index (ADX) is used to measure the strength or weakness of a trend, not the actual direction. In general, the bulls have the edge when +DI is greater than -DI, while the bears have the edge when -DI is greater. Crosses of these directional indicators can be combined with ADX for a complete trading system. One can say that these bi-directional lines are like two strong animals (a bull and a bear) pulling the market in both directions. In the above diagram, the uptrend overpowers the downtrend when the green line is above the red line.

It would have been prudent to ignore bearish signals with a bullish continuation pattern taking shape. By contrast, the June 2010 buy signal occurred near a resistance zone marked by broken support and the 50-62% retracement zone. In this instance, it would have been prudent to ignore a buy signal so close to this resistance zone. The best profits come from trading the strongest trends and avoiding range conditions. ADX not only identifies trending conditions, it helps the trader find the strongest trends to trade.

The ADX indicator takes an average of expanding price range values to show whether a security’s current price is in a bullish or bearish phase, and compares it with historical price chart​​ data. The purpose of the average directional movement index is to measure the strength of a trend and create buy or sell signals, depending if the trader should go long or short on an asset. ADX calculations are based on a moving average of price range expansion over a given period of time. The default setting is 14 bars, although other time periods can be used. ADX can be used on any trading vehicle such as stocks, mutual funds, exchange-traded funds and futures.

There are many trading strategies that use the ADX, either as the main entry trigger, or just as a filter. For instance, it’s not uncommon to see that the 10-period ADX only outputs half the reading of the 5-period ADX. This is also why you need to adjust the threshold values as you adjust the ADX length. For instance, a 5-period ADX will reach high readings much more frequently than a 20-period ADX.

The chart below shows an example of ADX with +DI and -DI using the Nasdaq 100 ETF (QQQQ). When price makes a higher high and ADX makes a lower high, there is negative divergence, or non-confirmation. In general, divergence is not a signal for a reversal, but rather a warning that trend momentum is changing. It may be appropriate to tighten the stop-loss or take partial profits.

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The chart reflects the values of +DI, -DI, and ADX over the course of the time interval. If the -DI is above the +DI, when the ADX moves above 25 that could trigger a short trade. There are a number of ways the DMI can be used to trade, in addition to the general guidelines discussed above. Directional movement is calculated by comparing the difference between two consecutive lows with the difference between their respective highs. Any time the trend changes character, it is time to assess and/or manage risk. Divergence can lead to trend continuation, consolidation, correction or reversal (below).

Any ADX peak above 25 is considered strong, even if it is a lower peak. In an uptrend, price can still rise on decreasing ADX momentum because overhead supply is eaten up as the trend progresses (shown below). To calculate adx indicator formula the ADX, first determine the + and – directional movement, or DM. The +DM and -DM are found by calculating the “up-move,” or current high minus the previous high, and “down-move,” or current low minus the previous low.

What Do Strong and Weak Readings ACTUALLY Tell Us?

The key, as always, is to incorporate other aspects of technical analysis. For example, the first group of whipsaws in September 2009 occurred during a consolidation. Moreover, this consolidation looked like a flag, which is a bullish consolidation that forms after an advance.

When the green is above the red line, it indicates uptrend in price. When there are frequent crossovers between red and green lines, there likely isn’t a price trend going on, and the price is moving sideways. https://traderoom.info/ Since ADX is non-directional, this shows the reversal is as strong as the prior trend. Traders may find readings other than 25 are better suited to indicate a strong trend in certain markets.

The ability to quantify trend strength is a major edge for traders. ADX also identifies range conditions, so a trader won’t get stuck trying to trend trade in sideways price action. In addition, it shows when price has broken out of a range with sufficient strength to use trend-trading strategies. ADX also alerts the trader to changes in trend momentum, so risk management can be addressed. If you want the trend to be your friend, you’d better not let ADX become a stranger.

Now, as you increase the length of the ADX, you’ll start to notice how it becomes less responsive and less likely to go into the really high readings. Even though the differences between this and the previous image aren’t that significant, they are big enough. The Negative Directional Movement (-DM), is equal to the current low minus the previous low, if it’s bigger than +DM and greater than zero. The Plus Directional movement(+DM) is equal to the current high minus the previous high, only if it’s greater than zero and bigger than -DM.

ADX Indicator – Technical Analysis

Read price first, and then read ADX in the context of what price is doing. When any indicator is used, it should add something that price alone cannot easily tell us. For example, the best trends rise out of periods of price range consolidation. Breakouts from a range occur when there is a disagreement between the buyers and sellers on price, which tips the balance of supply and demand.

  • In addition, it shows when price has broken out of a range with sufficient strength to use trend-trading strategies.
  • The ADX indicator is composed of a total of three lines, while the Aroon indicator is composed of two.
  • Whipsaws occur when the indicators criss-cross back and forth, resulting in multiple trade signals that produce losing trades.
  • Any time the trend changes character, it is time to assess and/or manage risk.
  • As well as on our own trading platform, we host the internationally recognised trading platform, MetaTrader 4, which comes with all standard features of an MT4 account.

All you have to do is apply the average directional index indicator to a chart, with all the necessary calculations done for you, according to whatever time frame you choose. Average Directional Index (ADX) is used to measure the magnitude of a trend, not the actual direction. A bullish signal occurs when +DI is greater than -DI, while a bearish signal occurs when -DI is greater. Crossovers of these directional indicators can be combined with ADX metric for a complete trading analysis. ADX trend line is the third line on the chart, and it displays the strength of the trend.

When we look for high ADX readings, we generally use static values to determine whether a reading is high or low. However, another approach that could be quite effective, would be to look for ADX highs  relative to the current ADX reading, to see which one is bigger. That way we adopt an adaptive approach that takes into account the recent performance of the market. As always, it’s paramount that you do your own testing and validation before trading any strategy or edge. The strategies below should primarily be seen as a source of inspiration,  but still are a great way to get started in the markets. However, keep in mind that different strategies may react very differently to high or low ADX readings.

How to use Average Directional Index in trading platform

A third line, the average directional index, or ADX, is nondirectional but shows movement strength. The ADX itself is then calculated as the sum of the differences between +DMI and –DMI over a given time period. The average directional movement index is calculated to reflect the expansion, or contraction, of the price range of a security over a period of time.

The indicator lags and will therefore tend to indicate trend changes after the price has already reversed course. This could lead to some trade signals occurring too late to be of use. A reading of 20, or 25, or 30 doesn’t mean that trend will persist. The indicator can’t predict a trend will continue, only that the security trended recently. Irrespective of whether the trader takes a long or short position, the ADX should be over 25 when the crossover occurs to confirm the trend’s strength.

  • Wilder features the Directional Movement indicators in his 1978 book, New Concepts in Technical Trading Systems.
  • Lower settings will make the average directional index respond more quickly to price movement but tend to generate more false signals.
  • SharpCharts users can plot these three directional movement indicators by selecting Average Directional Index (ADX) from the indicator dropdown list.
  • 77% of retail investor accounts lose money when spread betting and/or trading CFDs with this provider.

She has worked in multiple cities covering breaking news, politics, education, and more. Her expertise is in personal finance and investing, and real estate. The spreadsheet model retrieves quote information from a Web Service through a lightweight data-interchange format called JSON or JavaScript Object Notification. If this is your first time programming JSON in Excel, you must add certain excel libraries to start utilizing Bloomberg Markets Web Service through VBA. If the +DI is already above the -DI, when the ADX moves above 25 (or 20, 30) that could trigger a long trade. If you’re not familiar with the RSI indicator, we recommend that you have a look at our complete guide to the RSI Indicator.

What is the ADX?

Whether it is more supply than demand, or more demand than supply, it is the difference that creates price momentum. The negative directional index(DI-) shows the strength of positive price moves. When it’s sloping downwards, it’s a sign the downtrend is getting weaker. The positive directional index(DI+) shows the strength of positive price moves. When it’s sloping upwards, it’s a sign that the uptrend is getting stronger.

Some stocks have price characteristics similar to commodities, which tend to be more volatile with short and strong trends. Stocks with low volatility may not generate signals based on Wilder’s parameters. Chartists will likely need to adjust the indicator settings or the signal parameters according to the characteristics of the security. Using an ADX strategy to assess the performance of stocks allows traders to see when a particular share is overbought or oversold, according to the succession of lowering peaks. The stock market can be very volatile and share prices are often influenced by fundamental factors and economic events, such as news releases and earnings reports.

Thus, since the true range is the maximum of the three values, it would be 10. Before we move ahead with the ADX indicator-based strategies, let’s take a small example and see how the ADX indicator is calculated. We do not particularly recommend the ADX indicator for trading because we believe there are better tools out there to spot strong movements, such as the TTM Squeeze indicator. The ADX indicator is better used in a daily chart, as it will provide better information regarding the state of the asset we want to watch.

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The average directional index is, like momentum indicators such as the MACD or RSI, typically shown in a separate window above or below the main chart window that shows price. The ADX is shown as a line representing values that range from zero to 100. +DI and -DI are displayed as two distinct lines above or below the stock price. When the red line is above the green line, it means a downtrend in price.

adx indicator formula

This so-called Plus Directional Movement (+DM) then equals the current high minus the prior high, provided it is positive. Wilder features the Directional Movement indicators in his 1978 book, New Concepts in Technical Trading Systems. This book also includes details on Average True Range (ATR), the Parabolic SAR system and RSI. Despite being developed before the computer age, Wilder’s indicators are incredibly detailed in their calculation and have stood the test of time. Those interested in learning more about ADX and other financial topics may want to consider enrolling in one of the best technical analysis courses currently available.

When there are crosses between both +DI and -DI lines, it can signify potential trading signals, as a bearish or bullish market emerges. The first technique is used to smooth each period’s +DM1, -DM1 and TR1 values over 14 periods. As with an exponential moving average, the calculation has to start somewhere so the first value is simply the sum of the first 14 periods.

This bullish signal is reinforced if/when ADX turns up and the trend strengthens. Once the trend develops and becomes profitable, traders will have to incorporate a stop-loss and trailing stop should the trend continue. The high on the day of the sell signal becomes the initial stop-loss. The average directional index (ADX) is indicative of the overall strength and direction of a trend.

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