Created by legendary trader Welles Wilder in 1978, the Average Directional Movement Index (ADX) is a technical analysis tool used by traders to establish trend strength as well as trend direction. It is common investing wisdom that detecting and trading in the direction of a strong trend is a profitable strategy with minimal risk exposure. This is why ADX is one of the most popular indicators among traders of all levels. Functionally, the ADX is an excellent indicator for identifying the prevailing conditions in the market. Traders can easily determine whether a market is ranging or trending, and then apply the appropriate technical trading strategy. ADX belongs to the broader group of trend-following indicators. Other technical analysis indicators similar to ADX include the Parabolic SAR, Envelopes and Moving Averages.

ADX Calculation

The ADX indicator has 3 lines: +DI (green line), -DI (red line) and ADX (black line). These lines are calculated using the formulas below:

+DI = ((Smoothed MA + DM)/ATR) * 100
-DI = ((Smoothed MA – DM)/ATR) * 100
DX = ((+DI – -DI)/(+DI + -DI)) * 100

First ADX = sum n periods of DX / n
After that ADX = ((Prior ADX * n-1) + Current DX) /n

Where:
+DM = Current High – Previous High
-DM = Previous Low – Current Low
ATR = Average True Range
N = Number of periods used in the calculation (the default is usually 14 but traders can adjust this according to their needs)

The above calculation will plot the three lines of the ADX indicator. The +DI (green line) will be the positive directional indicator, whereas the –DI (red line) will be the negative directional indicator. The ADX (black line) is a non-directional indicator (essentially the average difference between +DI and –DI) and is plotted from 0 to 100, with no negative values.

Reading the ADX Indicator

As mentioned above, the ADX line is primarily a momentum indicator. Based on this, a rising ADX implies a strengthening trend, whereas a falling ADX implies a weakening trend. Welles provided the ADX trend strength scale as below:

ADX ValueTrend Strength
0-25Non-trending market or range-bound market
25-50Strong trend
50-75Very strong trend
75-100Extremely strong trend (rarely happens and can be considered unsustainable)

Trend direction is determined by watching the +DI and -DI lines. An uptrend is in place when the +DI is above the -DI; whereas a downtrend is in place when -DI is above the +DI. When +DI and -DI crosses, it indicates that a trend reversal is occurring. The trend is turning bullish if +DI is crossing above -DI; similarly, the trend is turning bearish if -DI is crossing above +DI. It will be a case of a particularly strong trend if a cross occurs when the ADX line is also going up.

Trading ADX Signals

The ADX delivers several price signals that can be traded in the market and learning how to trade these signals, could enhance your trading accuracy. These signals include:

  • Crossovers
    The main aim of using the ADX is to only focus on trading qualified opportunities in trending markets. This is why it is important to watch out for crossovers of the +DI and –DI lines. When the +DI crosses above the –DI line, it implies that the rate of positive price change in the market is greater than the negative price change. If this happens when the ADX is above 25, it is a solid signal to place buy orders. Similarly, when the -DI crosses above the +DI line, it implies that the rate of negative price change in the market is greater than the positive price change. If this happens when the ADX is below 25, it is a solid signal to place sell orders. Crossovers are as much a trigger of trade entry as they are for trade management and exits. For instance, if you are in a long position and the –DI line crosses above +DI, you can seek to protect your capital by locking in partial profits using trailing stops or by exiting your trade position entirely.
  • Finding Ranges
    The ADX is a trusted range finder in the markets. When the ADX reading falls below 25 and stays there for an extended period, it means that the market is trendless or basically ranging. Ranging markets are characterised by the price bouncing off recognisable support and resistance areas. In such markets, buy orders are placed off support areas, while sell orders are placed off resistance areas.
  • Breakouts
    A ranging market is bound to break out eventually. Breakouts frequently happen in the markets, and they can offer a big opportunity for traders. Although breakouts can easily be spotted, it can be very difficult to determine whether a breakout is valid or not. There are far too many fake breakouts that can literally leave traders trapped in a bad trade position. The ADX helps to validate breakouts. That is, when the price breaks out with an ADX reading of above 25, it implies that momentum in the new direction can be sustained. But a breakout with an ADX reading of below 25 is potentially unsustainable.

Main Pitfalls of the ADX Indicator

    1. Lagging Indicator – The ADX is calculated based on the moving averages of price range expansion over a given time, typically 14 periods. This means it reflects past price movements. Since it lags behind current market conditions, the ADX may signal a strong trend after the significant price movement has already occurred. Traders relying solely on the ADX may enter trades too late, missing optimal entry points.
    2. Non-Directional Indicator – ADX measures trend strength but does not indicate trend direction. Without additional indicators or analysis, traders might misinterpret the signal. A rising ADX reading suggests a strengthening trend but doesn’t specify whether it’s upward or downward. This can lead to confusion and potential losses if the trader misjudges the trend direction.
    3. False Signals in Ranging Markets – In sideways or choppy markets, the ADX can generate misleading signals. The ADX may fluctuate, causing traders to think a new trend is starting when the market is merely experiencing volatility within a range. Acting on these false signals can result in whipsaws i.e., sudden price changes that can trigger stop-loss orders.
    4. Delayed Response to Trend Changes – Due to its lagging nature, the ADX can be slow to respond to sudden changes or reversals in the market. Traders may hold onto positions longer than advisable because the ADX has not yet indicated a weakening trend. This delay can lead to losses in rapidly changing market conditions.
    5. Sensitivity to Parameter Settings – The default setting for ADX calculation is 14 periods, but this may not suit all trading styles or instruments. Inappropriate settings can make the ADX less responsive or too sensitive, either missing trends or generating too many false signals. Adjusting the period without proper backtesting can reduce the effectiveness of the indicator.
    6. Complexity in Interpretation – The ADX indicator is part of a system that includes the Positive Directional Indicator (+DI) and Negative Directional Indicator (-DI). Interpreting the relationships among ADX, +DI, and -DI can be complex, especially for beginners. Misinterpretation can lead to incorrect trading decisions, such as entering trades against the prevailing trend.
    7. Not Effective Alone – The ADX does not provide entry and exit signals on its own. Relying solely on the ADX without combining it with other technical tools like price action analysis or additional indicators (e.g., RSI, MACD) can result in incomplete assessments of the market, increasing the risk of poor trade execution.
    8. Ineffectiveness in Short Time Frames – The ADX tends to be less reliable on shorter time frames due to increased market noise. Day traders or scalpers may find that the ADX provides too many false signals when used on intraday charts, leading to frequent losses.
    9. Interpreting ADX Value Thresholds – Common thresholds (e.g., ADX above 25 indicates a strong trend) are not absolute and can vary between markets. Rigidly adhering to standard thresholds without considering the specific market context can lead to misjudging trend strength.

Tips to Mitigate ADX Pitfalls

  • Use in Conjunction with Other Indicators – Combine the ADX with trend direction indicators like moving averages or the +DI and -DI lines to ascertain both trend strength and direction.
  • Adjust Period Settings Thoughtfully – Test different ADX periods through backtesting to find the most effective setting for your trading style and the specific market type.
  • Be Cautious in Ranging Markets – Recognise when markets are sideways and avoid relying heavily on the ADX during these periods. Consider using oscillators like RSI or Stochastic in such conditions.
  • Monitor Price Action – Always confirm ADX signals with price movements and chart patterns to validate trends.
  • Stay Flexible – Be prepared to adjust your strategy if the ADX provides conflicting or unclear signals.
  • Educate Yourself – Invest time in understanding how ADX works and practice interpreting it correctly within the broader context of the market.

The ADX indicator can be a powerful tool for assessing trend strength, but it is not without limitations. Being aware of its pitfalls allows traders to use it more effectively, minimising false signals and enhancing trading decisions. By combining the ADX with other indicators, adjusting settings appropriately, and staying vigilant to market conditions, traders can mitigate many of the risks associated with its use.

Combining ADX with Other Indicators

To create clear and reliable trading signals, it’s beneficial to combine the ADX with other indicators that provide information about trend direction, momentum, and potential entry and exit points. Here are three excellent indicators to combine with ADX:

  1. Moving Averages (MA)
  2. Relative Strength Index (RSI)
  3. Moving Average Convergence Divergence (MACD)

Moving Averages (MA)

Purpose: Identify the direction of the trend and potential support/resistance levels.

Types

  • Simple Moving Average (SMA) – Calculates the average price over a specific number of periods.
  • Exponential Moving Average (EMA) – Gives more weight to recent prices, making it more responsive to recent market changes.

How It Complements ADX

  • Trend Direction – While the ADX measures trend strength, MAs indicate trend direction. Combining the two helps identify strong trends and their direction.
  • Crossover Signals – When a short-term MA crosses above a long-term MA, it signals a potential uptrend (Golden Cross). The opposite is true for a downtrend (Death Cross).

Usage Example

  • Entry Signal – If ADX is above 25 (indicating a strong trend) and the price is above the 50-day EMA (uptrend), consider entering a long position.
  • Exit Signal – If the price falls below the 50-day EMA while the ADX starts to decline, it may signal a weakening trend and a signal to exit.

Relative Strength Index (RSI)

Purpose: Measure the speed and change of price movements to identify overbought or oversold conditions.

How it Complements the ADX

  • Momentum Confirmation – The RSI provides insights into market momentum, which can validate the strength indicated by the ADX.
  • Entry and Exit Points – Helps pinpoint optimal entry and exit points within a trend.

Usage Example

  • Entry Signal in Uptrend
    • Condition – The ADX is above 25 (strong trend), and the RSI dips below 30 and then rises above it.
    • Action – Consider entering a long position as the market may be resuming its uptrend after a short-term pullback.
  • Exit Signal in Uptrend
    • Condition – The ADX remains high, but the RSI rises above 70 (overbought).
    • Action – Consider taking profits or tightening stop-loss orders.

Moving Average Convergence Divergence (MACD)

Purpose: Identify trend direction and momentum by comparing short-term and long-term moving averages.

Components

  • MACD Line – Difference between the 12-period EMA and the 26-period EMA.
  • Signal Line – 9-period EMA of the MACD line.
  • Histogram – Visual representation of the difference between the MACD line and the signal line.

How It Complements ADX

  • Trend Confirmation – The MACD crossovers can confirm the trend direction suggested by MAs and the strength indicated by the ADX.
  • Momentum Shifts – Divergences between the MACD and price can signal potential trend reversals despite a strong ADX reading.

Usage Example

  • Entry Signal in Downtrend
    • Condition – The ADX is above 25 (strong trend), the MACD line crosses below the signal line, and both are below zero.
    • Action – Consider entering a short position to align with the strong downtrend.
  • Exit Signal in Downtrend
    • Condition – The MACD line crosses above the signal line while the ADX starts to decrease.
    • Action – Consider exiting the short position as momentum weakens.

Combining the Indicators Effectively

  1. Identify Trend Strength with ADX
    • Strong Trend – ADX is above 25.
    • Weak Trend or Range – ADX is below 20.
  2. Determine Trend Direction with MAs
    • Uptrend: Price above MA, and MA is sloping upwards.
    • Downtrend: Price below MA, and MA is sloping downwards.
  3. Confirm Momentum and Entry Points with RSI and MACD
    • RSI:
  • Enter long positions when the RSI exits oversold territory in an uptrend.
  • Enter short positions when the RSI exits overbought territory in a downtrend.
    • MACD:
  • Look for the MACD line crossing the signal line in the direction of the trend.
  • Use histogram expansion to confirm the increasing momentum.

Practical Trading Scenario Using a Combined ADX Strategy

Scenario: You are analysing a stock to identify a potential trading opportunity.

  1. Assess Trend Strength with ADX
    • Observation – The ADX is at 30 and rising.
    • Interpretation – A strong trend is present.
  2. Determine Trend Direction with MA
    • Observation – The 50-day EMA is above the 200-day EMA, and both are sloping upwards. The price is trading above both EMAs.
    • Interpretation – The market is in an uptrend.
  3. Confirm with RSI
    • Observation – The RSI dipped to 40 and is now rising but below 70.
    • Interpretation – Momentum is strengthening, and there is room for the price to move higher before reaching overbought levels.
  4. Validate with MACD
    • Observation – The MACD line has just crossed above the signal line, and both are above zero. The histogram bars are increasing in size.
    • Interpretation – Bullish momentum is gaining strength.
  5. Trading Decision
    • Action – Enter a long position.
    • Stop-Loss – Place below the recent swing low or below a key moving average.
    • Take-Profit – Set based on the risk-reward ratio or key resistance levels.

Benefits of This Combination

  • Comprehensive Analysis – By integrating the ADX, MA, RSI, and MACD into your trading, you can cover trend strength, direction, momentum, and potential entry/exit points.
  • Reduced False Signals – Confirmation across multiple indicators reduces the likelihood of acting on false signals.
  • Flexibility – Applicable across various markets and timeframes.

Combining the ADX with Moving Averages, RSI, and MACD provides a robust framework for generating clear and reliable trading signals. This multi-indicator approach helps traders:

  • Identify strong trends and their direction.
  • Determine optimal entry and exit points.
  • Confirm momentum to increase trade confidence.

By leveraging the strengths of each indicator, traders can make more informed decisions and improve their trading performance.

Note: Always backtest your strategy and consider the specific context of the market you are trading. No combination of indicators can guarantee success but they can provide strong trading signals, however, it is essential to always implement proper risk management.

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Main ADX Indicator Trading Strategies FAQ

  • What is the ADX Indicator?

    The Average Directional Index, or ADX, is a trend indicator that is used to quantify the strength of a trend. It is plotted as a single line with a value between 0 and 100. Unlike other trend indicators the ADX is non-directional, meaning it simply register the strength of the trend, not whether it is an up-trend or a down-trend. In order to indicate whether prices are moving higher or lower the ADX Indicator is plotted with the +DMI and –DMI lines from which the ADX is derived.

  • What is the best ADX Indicator trading strategy?

    A simple and effective strategy that is used by many traders is a crossover strategy that uses the ADX in combination with the +DMI and –DMI lines. In this trading strategy an order is placed whenever the +DMI and –DMI lines cross, as long as the ADX is also above 25, indicating a strong trend. When the +DMI line crosses higher it is a buy signal and when the –DMI crosses higher it is a sell signal.

  • What other indicator works best with the ADX Indicator?

    The ADX Indicator actually works best when combined with other technical indicators. One of the best combinations is with the Relative Strength Index, or RSI. Because the ADX measures the intensity of the trend the RSI can help with entries and exits by giving a time based component to the trend. In this case traders should wait for confirmation of a downtrend by an RSI reading of less than 30, or confirmation of an uptrend by an RSI reading above 70 before placing an order.

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** Disclaimer – While due research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.