ADX: The Trend Strength Indicator
Trading in the direction of a strong trend reduces risk and increases profit potential. The average
directional index (ADX) is used to determine when the price is trending strongly. In many cases, it is
the ultimate trend indicator. After all, the trend may be your friend, but it sure helps to know who
your friends are. In this article, we'll examine the value of ADX as a trend strength indicator.
Introduction to ADX
ADX is used to quantify trend strength. ADX calculations are based on a moving average of price range
expansion over a given period of time. The default setting is 14 bars, although other time periods can
be used. ADX can be used on any trading vehicle such as stocks, mutual funds, exchange-traded funds
and futures.
ADX is plotted as a single line with values ranging from a low of zero to a high of 100. ADX is non-
directional; it registers trend strength whether price is trending up or down. The indicator is usually
plotted in the same window as the two directional movement indicator (DMI) lines, from which ADX is
derived (Figure 1).
For the remainder of this article, ADX will be shown separately on the charts for educational purposes.
Figure 1: ADX is non-directional and quantifies trend strength by rising in both uptrends and
downtrends.
When the +DMI is above the -DMI, prices are moving up, and ADX measures the strength of the
uptrend. When the -DMI is above the +DMI, prices are moving down, and ADX measures the strength
of the downtrend. Figure 1 is an example of an uptrend reversing to a downtrend. Notice how ADX
rose during the uptrend, when +DMI was above -DMI. When price reversed, the -DMI crossed above
the +DMI, and ADX rose again to measure the strength of the downtrend.
Quantifying Trend Strength
ADX values help traders identify the strongest and most profitable trends to trade. The values are also
important for distinguishing between trending and non-trending conditions. Many traders will use
ADX readings above 25 to suggest that the trend is strong enough for trend-trading strategies.
Conversely, when ADX is below 25, many will avoid trend-trading strategies.
ADX Value Trend Strength
0-25 Absent or Weak Trend
25-50 Strong Trend
50-75 Very Strong Trend
75-100 Extremely Strong Trend
Low ADX is a usually a sign of accumulation or distribution. When ADX is below 25 for more than 30
bars, price enters range conditions, and price patterns are often easier to identify. Price then moves up
and down between resistance and support to find selling and buying interest, respectively. From low
ADX conditions, price will eventually break out into a trend. In Figure 2, price moves from a low ADX
price channel to an uptrend with strong ADX.
Figure 2: When ADX is below 25, price enters a range. When ADX rises above 25, price tends to trend
Figure 3: Periods of low ADX lead to price patterns. This chart shows a cup and handle formation that
starts an uptrend when ADX rises above 25.
The direction of the ADX line is important for reading trend strength. When the ADX line is rising,
trend strength is increasing, and the price moves in the direction of the trend. When the line is falling,
trend strength is decreasing, and the price enters a period of retracement or consolidation.
A common misperception is that a falling ADX line means the trend is reversing. A falling ADX line only
means that the trend strength is weakening, but it usually does not mean the trend is reversing, unless
there has been a price climax. As long as ADX is above 25, it is best to think of a falling ADX line as
simply less strong (Figure 4).
Figure 4: When ADX is below 25, the trend is weak. When ADX is above 25 and rising, the trend is
strong. When ADX is above 25 and falling, the trend is less strong.
Trend Momentum
The series of ADX peaks are also a visual representation of overall trend momentum. ADX clearly
indicates when the trend is gaining or losing momentum. Momentum is the velocity of price. A series
of higher ADX peaks means trend momentum is increasing. A series of lower ADX peaks means trend
momentum is decreasing. Any ADX peak above 25 is considered strong, even if it is a lower peak. In an
uptrend, price can still rise on decreasing ADX momentum because overhead supply is eaten up as the
trend progresses (Figure 5).
Figure 5: ADX peaks are above 25 but getting smaller. The trend is losing momentum but the uptrend
remains intact.
Knowing when trend momentum is increasing gives the trader confidence to let profits run instead of
exiting before the trend has ended. However, a series of lower ADX peaks is a warning to watch price
and manage risk. The best trading decisions are made on objective signals, not emotion.
ADX can also show momentum divergence. When price makes a higher high and ADX makes a lower
high, there is negative divergence, or non-confirmation. In general, divergence is not a signal for a
reversal, but rather a warning that trend momentum is changing. It may be appropriate to tighten the
stop-loss or take partial profits.
Any time the trend changes character, it is time to assess and/or manage risk. Divergence can lead to
trend continuation, consolidation, correction or reversal (Figure 6).
Figure 6: Price makes a higher high while ADX makes a lower high. In this case, the negative divergence
led to a trend reversal.
Strategic Use of ADX
Price is the single most important signal on a chart. Read price first, and then read ADX in the context
of what price is doing. When any indicator is used, it should add something that price alone cannot
easily tell us. For example, the best trends rise out of periods of price range consolidation. Breakouts
from a range occur when there is a disagreement between the buyers and sellers on price, which tips
the balance of supply and demand. Whether it is more supply than demand, or more demand than
supply, it is the difference that creates price momentum.
Breakouts are not hard to spot, but they often fail to progress or end up being a trap. But ADX tells you
when breakouts are valid by showing when ADX is strong enough for price to trend after the breakout.
When ADX rises from below 25 to above 25, price is strong enough to continue in the direction of the
breakout.
ADX as a Range Finder
Conversely, it is often hard to see when price moves from trend to range conditions. ADX shows when
the trend has weakened and is entering a period of range consolidation. Range conditions exist when
ADX drops from above 25 to below 25. In a range, the trend is sideways and there is general price
agreement between the buyers and sellers. ADX will meander sideways under 25 until the balance of
supply and demand changes again. (For more, see: Trading Trend or Range?)
ADX gives great strategy signals when combined with price. First, use ADX to determine whether
prices are trending or non-trending, and then choose the appropriate trading strategy for the
condition. In trending conditions, entries are made on pullbacks and taken in the direction of the
trend. In range conditions, trend-trading strategies are not appropriate. However, trades can be made
on reversals at support (long) and resistance (short).
The Bottom Line: Finding Friendly Trends
The best profits come from trading the strongest trends and avoiding range conditions. ADX not only
identifies trending conditions, it helps the trader find the strongest trends to trade. The ability to
quantify trend strength is a major edge for traders. ADX also identifies range conditions, so a trader
won't get stuck trying to trend trade in sideways price action. In addition, it shows when price has
broken out of a range with sufficient strength to use trend-trading strategies. ADX also alerts the
trader to changes in trend momentum, so risk management can be addressed. If you want the trend to
be your friend, you'd better not let ADX become a stranger. (For further reading, check out: Keep It
Simple and Trade With the Trend.
