|
Average Directional Index (ADX)
J. Welles Wilder developed the Average Directional Index (ADX) to evaluate
the strength of a current trend, be it up or down. It's important to determine
whether the market is trending or trading sideways, because certain indicators
give more useful results depending on the market doing one or the other.
The ADX is an oscillator that fluctuates between 0 and 100. Even though the
scale is from 0 to 100, readings above 60 are relatively rare. Low readings,
below 20, indicate a weak trend and high readings, above 40, indicate a strong
trend. The indicator does not grade the trend as bullish or bearish, but merely
assesses the strength of the current trend. A reading above 40 can indicate
a strong downtrend as well as a strong uptrend.
ADX can also be used to identify potential changes in a market from trending
to non-trending (sideways). When ADX begins to strengthen from below 20 and
moves above 20, it is a sign that the trading range is ending and a trend is
developing.
When ADX begins to weaken from above 40 and moves below 40, it is a sign
that the current trend is losing strength and a trading range could develop.
Directional Indicators
The ADX is derived from two other indicators, also developed by Wilder, called
the Positive Directional Indicator (usually written as +DI) and the Negative
Directional Indicator (-DI).
When the ADX Indicator is selected, SharpCharts plots the Positive Directional
Indicator (+DI), Negative Directional Indicator (-DI) and Average Directional
Index (ADX). With the Default color scheme on SharpCharts, ADX is the thick
black line with less fluctuation, +DI is green and -DI is red. +DI measures
the force of the up moves and -DI measures the force of the down moves over
a set period. The default setting is 14 periods, but users are encouraged to
modify these settings according to their personal preferences.
In its most basic form, buy and sell signals can be generated by +DI/-DI
crosses. A buy signal occurs when +DI moves above -DI and a sell signal when
-DI moves above the +DI. Be careful, though; when a security is in a trading
range, this system may produce many whipsaws. As with most technical indicators,
+DI/-DI crosses should be used in conjunction with other aspects of technical
analysis.
The ADX combines +DI with -DI, and then smooths the data with a moving average
to provide a measurement of trend strength. Because it uses both +DI and -DI,
ADX does not offer any indication of trend direction, just strength. Generally,
readings above 40 indicate a strong trend and readings below 20 a weak trend.
To catch a trend in its early stages, you might look for stocks with ADX that
advances above 20. Conversely, an ADX decline from above 40 might signal that
the current trend is weakening and a trading range is developing.
ADX (white
line) measures the strength of a trend. Notice the first circle indicates a
strengthening trend, which is manifest for the next several weeks. The second
circle indicates a re-strengthening of a trend, while the third circle indicates
a flattening, or "sideways" pattern is developing.
|
