Average Directional Movement Index
Average Directional Movement Index Technical Indicator (ADX) helps to determine
if there is a price trend. It was developed and described in detail by Welles Wilder in
his book "New concepts in technical trading systems".
The simplest trading method based on the system of directional movement implies
comparison of two direction indicators: the 14-period +DI one and the 14-period -DI.
To do this, one either puts the charts of indicators one on top of the other, or +DI is
subtracted from -DI. W. Wilder recommends buying when +DI is higher than -DI,
and selling when +DI sinks lower than -DI.
To these simple commercial rules Wells Wilder added "a rule of points of extremum".
It is used to eliminate false signals and decrease the number of deals. According to
the principle of points of extremum, the "point of extremum" is the point when +DI
and -DI cross each other. If +DI raises higher than -DI, this point will be the
maximum price of the day when they cross. If +DI is lower than -DI, this point will
be the minimum price of the day they cross.
The point of extremum is used then as the market entry level. Thus, after the signal to
buy (+DI is higher than -DI) one must wait till the price has exceeded the point of
extremum, and only then buy. However, if the price fails to exceed the level of the
point of extremum, one should retain the short position.
Calculation
ADX = SUM[(+DI-(-DI))/(+DI+(-DI)), N]/N
Where:
N — the number of periods used in the calculation.