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The Average Directional Index

The Average Directional Index

James Stanley, Senior Strategist
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The Average Directional Index (ADX)

Traders will often struggle with finding trends. After all, there’s numerous ways to qualify a trend and such an observation is a highly subjective ordeal. What might be a workable trend may not be to you, and this could have large impacts in how we each choose to deploy strategies, even if looking at the same market.

While moving averages or price action can be helpful in denoting whether or not a market is trending, there’s an indicator that’s designed to do exactly that, and that’s the Average Directional Index.

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The Average Directional Index, or ADX, was created by J. Welles Wilder who also created the Relative Strength Index (RSI), Average True Range (ATR) and Parabolic SAR. The Average Directional Index was created to illustrate trend strength, which can then show traders possible viability of continuation.

The indicator displays in its own panel and on the below chart, ADX is plotted below price. Notice how trends will drive the indicator’s value higher while ranges or mean-reversion will allow for the indicator to recede.

On the below weekly chart of EUR/USD, the ADX indicator has been applied, and notice how the indicator gains in value for each of the observed trends in the below chart.

EUR/USD Weekly Price Chart

Chart prepared by James Stanley, EUR/USD Weekly, 2014-2022

How to Use ADX

While many technical indicators try to be a Swiss army knife in trying to do many things at once, ADX is solely designed for noticing trend strength. The stronger the trend, the higher the value of ADX, and this can be advantageous for traders provided that it’s used in the proper manner.

ADX is ill-suited for triggering entries or identifying overbought/oversold conditions. It can, however, deliver a value to the trader that can highlight whether the trend at the time is strong or not; but perhaps more importantly that can lead to the decision as to whether or not the trader can expect it to continue.

One common usage of ADX is to use a cut-off value to denote trends. Readings above the value indicate a trend being in-place, with higher values showing stronger trends. This can allow a trader to use the indicator as a type of denotation towards which types of strategies to employ. On the below chart, I’ve added a line at the value of 30 and this is the same weekly chart of EUR/USD as above.

With this, traders can look at trading trend strategies when ADX is reading above 30; and while it’s below the 30-level, traders can investigate either range or breakout strategies.

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EUR/USD Weekly Price Chart with ADX Applied

Chart prepared by James Stanley, EUR/USD Weekly, 2014-2022

--- Written by James Stanley, Senior Strategist for DailyFX.com

Contact and follow James on Twitter: @JStanleyFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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