ADX Average Directional Index

The Average Directional Movement Index (ADX) technical analysis indicator describes when a market is trending or not trending. When combined with the DMI+ plus and DMI- minus (see: DMI) the ADX can generate buy and sell signals. However, the main purpose of the ADX is to determine whether a stock, future, or currency pair is trending or is in a trading range. Determining which mode a market is in is helpful because it can guide an investor or trader as to which other technical analysis indicators to use.

• Trending Market: Use moving averages, trendlines, and other trend following technical indicators.
• Trading Range Market: Use oscillators like Stochastic Fast & Slow, RSI, or Williams %R and other range-bound indicators like Bollinger Bands or Moving Average Envelopes.

The ADX is so popular because determining whether a stock, commodity, or currency market is trending or not trending can help a trader avoid the pitfalls of some indicators.

• Moving Averages: Moving averages and their variants are effective during trending markets; however, during consolidation periods when prices go up and down, but in no direction, moving average indicators have a tendency to give numerous false buy and sell signals that add up to stock trading, futures trading, or currency trading losses.
• Oscillators: Oscillators are extremely effective in non-trending markets. Buying low and selling high is accomplished quite readily with oscillators. Unfortunately, during trending markets, oscillators perform quite poorly, often selling short during a bull market run or buying during a bear market downtrend, adding up to large losses.

The chart of the E-mini Russell 2000 Index Futures contract below shows an excellent example of the ADX in action:

1. Strong upward trend of stock, future, or currency = Increasing ADX
2. Strong downward trend = Increasing ADX

As can be referenced from the chart of the E-mini Russell 2000 Index Futures contract above, when the e-mini future was rising in a strong upward trend, the ADX indicator was rising.

When the e-mini futures contract moved into a non-directional consolidation phase, the ADX decreased.

The importance of the 20-level and 40-level, along with more examples of the ADX in action, is covered on the next page.