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The Average Directional Movement Index, also known as the ADX was invented by Welles Wilder, a known Technical Indicator pioneer, to gauge trend strength. It is a signal and filter indicator, whose main goal is to estimate strength of trends and give reversal signals. It is especially useful in FOREX trading, as most of the trading is intra-day, and about 80% of the time price is not in a trend, but in a range.

In this article we will describe the calculation of the indicator, its strengths and weaknesses and several trading methods that use it.

 Absolutely NO THINKING is needed, just buy when Blue and sell when Red!

Calculation and Formula
The calculation of the ADX starts with calculating the Directional Movement.
Directional Movement is defined as the greater of the two numbers: High of current bar - (minus) High of previous bar OR Low of current bar - Low of previous bar.

Directional Movement = Max(High[0]-High[1],Low[0]-Low[1])
If The DM is positive is DI+ and if it is negative it is DI-.

An average of the DI+ and DI- is then smoothed using a 14-Period exponential Moving Average, and divided in the True Range.

Trading Signals
The ADX indicators can be traded in several methods. First one is based on the DI+ and DI- lines:

Go Long when DI+ crosses DI- from below.
Go Short when DI- crosses DI+ from below.

This is a trend-following approach that gives many whipsaw signals. Filter these signals with extra indicators for confirmation.

Trading Systems
While the official trading methods described in Welles' book, New Concepts In Technical Analysis are not many, there are many trading systems that incorporate the ADX.

Parabolic ADX System
This is a trading system based on the Parabolic SAR Indicator (Also developed by Welles Wilder) and the ADX indicator.

Enter Long when Parabolic is Long and DI+ crosses DI- from below.
Enter Short when Parabolic is Shortand DI- crosses DI+ from below.

This is a variation of the official trading method, with Parabolic SAR as confirmation.