Stocks & Commodities V.

9:3 (101-102): The Average Directional Movement Index (ADX) by Thom Hartle

The Average Directional Movement Index (ADX)

by Thom Hartle

D irectional movement, according to technician J. Welles Wilder, is one of the most interesting aspects
of market analysis. Markets clearly move from trending periods to trading ranges, but determining when
this change occurs presented a challenge. To meet this challenge Wilder developed the Average
Directional Movement Index (ADX).
The Average Directional Movement Index is an indicator that is designed to rate the directional
movement of stocks or commodities. The index uses a scale of zero to one hundred to rate the trend
intensity of a tradable. Various markets can be followed and evaluated for trend intensity. After rating
each market, you use trend-following systems on the tradeables with a high rating. The tradeables with a
low rating on the ADX scale should be followed using a trading range system.
Determining the ADX value is a five-step process and begins with an evaluation of the basic directional
movement of the market. There will be only one directional movement value for each day. First, today's
high is compared with yesterday's high (Figure 1, points A and C). This difference is defined as the plus
directional movement (+DM). Comparing today's low with yesterday's low (Figure 2, points B and D)
defines the minus directional movement (-DM). Minus DM is for the purpose of labeling the value only;
the value of the -DM is always a positive number. Whichever reading is larger, +DM or -DM, will be
used for each day.
For outside days, the larger of the two directional movements is used (Figure 3). If today's trading range
is within or equal to yesterday's range (Figure 4), the directional movement value will be zero.
Basically, if the largest portion of today's range is higher than yesterday's range, then the DM value is
labeled +DM. A -DM value is assigned if the largest portion of today's range is below yesterday's range
(remember, both values are positive integers).
The next step in calculating ADX is to determine the percent of the price range that is directional for each
day. Determine the percentage of directional movement by dividing today's DM value by the true range
(TR) value. True range is the largest of the following:

The price difference between today's high and today's low.

The price difference between today's high and yesterday's close.

The price difference between today's low and yesterday's close.
The value that results from dividing DM by TR is called the Directional Indicator (DI). If the day has a
positive DM, then DI will be positive, while a day with a minus DM will be labeled minus DI. Each of
the values that have been calculated thus far are positive numbers; the minus signs are for descriptive
forms.

+Directional Indicator = +DM / TR

-Directional Indicator = -DM / TR

Article Text Copyright (c) Technical Analysis Inc. 1

Stocks & Commodities V. 9:3 (101-102): The Average Directional Movement Index (ADX) by Thom Hartle

FIGURE 1: Subtract today's high from yesterday's high (c) to determine the +DM.

FIGURE 2: Subtract today's low(D) from yesterday's low (B) to calculate the -DM.
Stocks & Commodities V. 9:3 (101-102): The Average Directional Movement Index (ADX) by Thom Hartle

FIGURE 3: For outside days, the greatest range outside of yesterday's range is used.

FIGURE 4: For inside days, the value of DM is zero.

Stocks & Commodities V. 9:3 (101-102): The Average Directional Movement Index (ADX) by Thom Hartle

The original calculation of ADX was based on a 14-day smoothed moving sum of both the plus DI values
and the minus DI values. Any period of time, however, may be used to determine ADX.
At this point, sum the values for the last 14 days of the individual variables +DM, -DM and TR. The
resultant value for the sums of each variable are used for the calculation of the 14-day Directional
Indicators:

+Directional Indicator14 = +DM14 / TR14

-Directional Indicator14 = -DM14/ TR14

To calculate the +DI and -DI on an ongoing basis, use the previous day's 14-period value (for each +DM,
-DM and TR) multiplied by 13/14. This value is added to today's raw value to compute the new smoothed
moving sum. For example:

+DM14(today) = Previous +DM14 times (13/14) plus +DMtoday

The directional index (DX) was devised to indicate trending on a scale of zero to one hundred. This is
accomplished by dividing the absolute value of the difference between +DM14 and -DM14 by the sum of
+DM14 and -DM14:

+DM 14 minus - DM 14
Directional Movement Index =
+DM 14 plus - DM 14

The ADX is the 14-day moving average of the directional movement index. Once 14 days' worth of ADX
values have been accumulated, future values can be determined by multiplying yesterday's ADX by 13/14
and then adding today's DX value. Calculate the ADX:

ADX14 = ADXyesterday times 13/14 plus ADX today

The ADX value can be used for all markets to ascertain which market is demonstrating the highest degree
of trend relative to other markets. Tabulating the order of the trending markets focuses the trader's
attention on which markets are trending and which are in trading ranges. In Figure 5, Microsoft is
trending during September and October, while Apple (Figure 6) is not trending, reflected by the lower
ADX rating.
As a trading system, the ADX can be used to generate trading signals. The general rule for trading based
on ADX is to go long when the +DI14 crosses above -DI14 and go short when the -DI14 crosses over the
+DI14 (Figure 7). This approach is a trend-following style, so you should only trade those markets that
are highest on the ADX scale.

FURTHER READING
Wilder, J. Welles [1978]. New Concepts in Technical Trading Systems . Trend Research.

Figures Copyright (c) Technical Analysis Inc. 2

Stocks & Commodities V. 9:3 (101-102): The Average Directional Movement Index (ADX) by Thom Hartle

FIGURE 5: High ADX values were generated as long as Microsoft was in a strong trend.

FIGURE 6: Apple stayed in a trading range during the last half of 1989 until December. The ADX
increased dramatically when the price of the stock began to trend.
Stocks & Commodities V. 9:3 (101-102): The Average Directional Movement Index (ADX) by Thom Hartle

FIGURE 7: ADX can be used as a trend-following system. A buy signal is generated when the +DI line
(solid line) crosses above the -Dl line (dotted line). A sell signal occurs when the -Dl line crosses below
the +DI line.