The Average Directional Movement, commonly referred to as ADX, is an indicator developed by J. Welles Wilder, an American mechanical engineer known for his technical analysis works and father of some of the most used indicators in automatic trading software (such as example ATR, RSI and Parabolic SAR).
It is an indicator that is used to determine the intensity of the trend and is able to identify whether the financial instrument observed is in a directional or lateral phase.
ADX, however, does not show us whether the direction of the trend is up or down, but will only confirm its intensity.
The ADX is presented as a single line, which moves on an abscissa indicating the time and an ordinate marked on a scale from 0 to 100 representing the strength of the trend in absolute value. The ADX line applied to the financial instrument studied indicates whether we are in a trend (trending range) or non-trend (trading range) situation; in the case of ascertained strength, ADX does not show us whether the direction of the trend is up or down, but will only confirm its intensity.
We have already said that the Average Directional Movement line does not indicate the direction of the trend, but only its strength.
The standard set-up of this indicator is set over a period of 14 trading sessions. Based on this set-up, considering the absolute value of the trend strength on a scale from 0 to 100 on the ordinate line, it is possible to establish three distinct situations.
Strength of the trend
Absence or very weak tendency
Start of the trend
We pay attention to the very high values of ADX because when it starts to reverse direction, it is likely that the primary trend will change.
Having clarified the operation of the ADX, the trader, to operate, will rarely use it without other filters because this alone does not provide signals on the direction of the trend. The Positive Directional Indicator and Negative Directional Indicator commonly known as + DI and –DI come into play. The interaction between these two indicators, which are very simple to use, show us the directionality of the current trend.
To interpret the directionality of the trend, the ADX is then integrated with these other two indicators (+ DI and -DI) whose movements we will study, giving life to the Directional Moving Index (DMI).
+ DI and -DI, in setup, are configured as two lines, the first in green and the second in orange which interact with each other.
In conclusion, the DMI indicator is composed of three lines: that of the ADX which shows the trend or non-trend situation with relative intensity of the latter and those of +DI and -DI which interacting with each other indicate the directionality of the current trend.
The intersection of the two lines + DI and -DI provides a signal that shows the operator a buying or selling area. In particular, if the + DI line intersects upwards, from the bottom upwards, the -DI line, there is a buy signal, on the contrary, if the -DI line intersects downwards, from top to bottom the line + DI you have a sell signal.
It is also important to consider how extreme are the levels achieved by these two indicators. Often, in fact, when they reach important values, we are faced with a possible trend inversion or a slowdown in the trend itself.
The chart used is of the PLUG POWER title. The green lines identify the moment when + DI crosses upward -DI. It is noted how, when the green indicator line (+ DI) is above the orange one (-DI), a buy signal is generated and consequently the relative movement of the stock is up. Conversely, when the orange line of the indicator (-DI) crosses the green line (+ DI) from the bottom upwards, it generates a SELL signal.
It is important to note that the ADX line (in the graph represented in red) remains constantly above level 20, exceeding level 40 in some phases, confirming the great strength of the trend. The value 20 has a key importance for the beginning of the directionality of the movement, thus giving greater strength to the BUY (or SELL) signal that has just occurred.
When the ADX is at the level of the value 20 or below, we can see how all the lines flatten creating a TRADING RANGE, that is, a lateral movement.