7 min read 

The Average Directional Index (ADX) is a technical analysis tool used to measure the trend strength. The plus directional indicator (+DI) and the minus directional indicator (-DI) accompany the ADX line, highlighting the direction of the trend. Used together they form a trading system that is able to determine both the direction and strength of the trend.

The ADX is used to identify strong trends and potentially profitable entry and exit points. This indicator was developed and introduced to the public by Welles Wilder, a twentieth-century technical analysis guru.

ADX as displayed in the IQ Option trading platform
ADX as displayed in the IQ Option trading platform

The logic behind

How strong is the current trend? This is the question the ADX is perfectly capable of answering. The indicator was created with the sole purpose of quantifying the trend strength.

The moving average of price range expansion is used as the foundation of the ADX. The indicator consists of three lines: the ADX itself (yellow line), a +DI line (green line), and a -DI line (red line). The +DI measures the strength of the uptrend, while the -DI measures the intensity of the downward movement. The ADX line shows the overall trend strength by rising in both uptrends and downtrends.

The index consists of three major lines
The index consists of three major lines

When the +DI is above the -DI, bulls are said to have the directional edge. Alternatively, when the -DI is higher than the +DI, the directional edge belongs to bears.

It is important to understand that the ADX (the yellow line) demonstrates only the trend strength and not the direction of the trend. Trend direction can be determined by looking at the +DI and -DI (red and green lines) instead.

ADX line shows trend strength, +DI and -DI lines show trend direction
ADX line shows trend strength, +DI and -DI lines show trend direction

How to set up?

Setting up the Average Directional Index in the IQ Option platform is easy.

Click on the “Indicators” button in the bottom left corner of the screen. Then choose the ADX from the list of possible indicators.

Setting up the indicator. Step one
Setting up the indicator. Step one

Go to the “Set up & Apply” tab and simply click the “Apply” button if you want to use the indicator with standard parameters. Or you can adjust the latter to your liking. Note that by increasing the period you cut down ADX’s sensitivity and at the same time boost the indicator’s accuracy.

Setting up the indicator. Step two
Setting up the indicator. Step two

The ADX is ready for use.

How to use in trading?

There are two major ways to use the indicator:

1) DI Crossover

When the plus and the minus directional lines cross it usually means that the trend is reversing. This information can be used to determine optimal entry points. For investors who utilize this trading system the signals are the following:

  • Enter the market (buy call options) when the +DI is above the -DI and the general trend is upward.
+DI and -DI bullish crossover
+DI and -DI bullish crossover
  • Leave the market (buy put options) when the +DI is below the -DI and the general trend is downward.
+DI and -DI bearish crossover
+DI and -DI bearish crossover

2) Trend Strength

In trading, not only the direction of the trend matters. The trend strength is also important as it defines the amount of profit a Forex trader would be able to pull out of a deal. There are even situations (e. g. utilizing the strangle trading strategy) when the direction of the trend doesn’t matter until market volatility is high enough.

The ADX ranges from 0 to 100 with 0 being an equivalent of the absolutely flat market and 100 — an extremely powerful trend.

ADX Value Trend Strength
0-25 Absent or Weak Trend
25-50 Strong Trend
50-75 Very Strong Trend
75-100 Extremely Strong Trend

 

In this case, the ADX can be combined with other indicators that show the direction of the future price action movement.

Conclusion

The Average Directional Index is a truly unique technical analysis indicator that, combined with other indicators, can become an great trading tool in the hands of a trader. Used in a combination with +DI and -DI lines (as suggested in the IQ Option platform) it is not only capable of predicting the trend strength, but also the trend direction.

As any other indicator, however, it should be used with caution and double checked on different time frames. The ADX may be lagging behind the actual trend and can therefore provide outdated information.

Practice now

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future

GENERAL RISK WARNING

The financial services provided by this website carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.

Recommended for you