An Introduction to ADX

ADX is a wonderful momentum indicator created by J Welles Wiler Jr. He is also credited for the creation of other momentum indicators. Momentum is defined as the rate of change of price. If the rate of change of price is quick, the momentum is said to be high. If the rate of change of price is slow, the momentum is said to be low. Momentum differs from Trend. Trend tells the trader about the direction of the price whereas momentum tells about the speed of the change in price.

ADX is used as an indicator to gauge the strength of the trend and the momentum by which the price is changing.

The calculation of ADX is crucial to understand the logic behind this indicator.

Logic and Formulas

ADX is an oscillator that oscillates between 0 and 100. When plotted on the charts, it plots 3 lines: ADX line, +DI line, and -DI line. The formula for 14 period ADX, +DI, and -DI line is as follows:

+DM and -DM is calculated as follows:

When the current price closes above the previous close, it is a +DM (Positive Directional Movement) day. When the current price closes below the previous close, it is a -DM (Negative Directional Movement) day.

+DM and -DM are further used to calculate +DI and -DI. +DI and -DI is used to calculate DX. The DX is then used to calculate ADX.

Although this looks complex, the calculation is simplified thanks to modern day trading software.

How the ADX line moves is depended on the gap between +DI and -DI line. When the gap between +DI and -DI line increases, the ADX line increases. This is irrespective of whether the +DI is above -DI line or vice versa.

Bias in ADX

Bias in ADX means the dominance of bullish sentiment or bearish sentiment. When +DI line is above -DI line, it is a Positive bias and hence shows a bullish sentiment. When -DI line is above the +DI line, it is a Negative bias and hence shows a bearish sentiment. Positive bias shows a bullish trend and Negative bias shows a bearish trend; Strength of the trend is a function of ADX line

Levels in ADX

The levels of ADX give significant information about the strength of the trend no matter bearish or bullish.

The levels of ADX are as follows:

• 0 - 15: Extremely weak trend

• 15- 25: Weak trend

• 25 - 50: Strong trend

• 50 - 75: Very Strong trend

• 75 - 100: Extremely strong trend

Putting it all together

Till this point, the formula of ADX, Bias in ADX, and Levels in ADX have been explained separately. Let us try and put these together to understand how to use ADX. But first, let us add 21 EMA line as a trend filter; Price above EMA line is bullish trend and price below EMA line is a bearish trend. So,

Positive bias + Price above moving average + ADX above 25 level suggest a strong bullish trend.

Negative bias + Price below moving average + ADX above 25 level suggests a strong bearish trend.

It is logical to trade breakouts when the above criteria is satisfied.

This logic can be used on Candlestick charts, PnF charts, and Renko charts.

Observe in the above chart of TORNTPHARM that after ADX crossed 25 above the EMA channel, the Market Structure Low could have been an entry trigger.

In the above chart of ACC, when the ADX moved above 25, the price entered into a strong up trend.

Observe in the above chart of AARTIIND that when the price entered into a downtrend after moving below the TMA, the ADX was consistently above 25 levels.

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