The average directional index (ADX) is an indicator used by technical analysts as an objective value for the strength of a trend. This indicator is non-directional, which means that trend’s strength is quantified, whether its movement is an uptrend or downtrend.
To evaluate a pattern over time, as well as to confirm a continuation or trend reversal, technicians used the ADX indicator. It is developed by Welles Wilder to assess commodities, daily prices and for stock selection.
Plus directional movement or +DM and the minus direction movement or –DM is both used to identify the ADX.
In essence, it is plotted in a chart window along with two lines called DMI or Directional Movement Indicators.
Analysts used ADX method to evaluate trends and helps traders to identify the strongest trends possible.
Two Forms of Stock Analysis
· Fundamental Analysis
- Selects stocks based on business performance
· Technical Analysis
- Select stocks based on price movement
Given that traders suggests that a trend is a significant factor, it has occurred that numerous trading indicators are meant to confirm a trend. Identifying a trend remains challenging as it is determined at the best time of entry and exit of a trade.
Plus Directional Movement (+DM) and Minus Directional Movement (-DM) forms the Average Directional Index (ADX) backbone. A movement is determined by the difference of the two consecutive lows vs. the difference of the session highs.
A directional movement is considered positive or plus when the current high minus the prior high is greater than the previous low minus the current low. In addition, the +DM then equals the current high minus the prior high, provided it is a positive.
Hence, if the value is negative, it would simply be entered as zero.
Further, a directional movement is considered negative or minus when the previous low minus the current low is grater than the current high minus the prior high. Moreover, the –DM then equals the previous low minus the current low, provided it is positive.
Thus, if the value is negative, it would simply be entered as zero.
Once a trend is identified, traders will start using the ADX. A trend is considered strong if it's positioned above 25; likewise, there is no trend when the ADX drops below 20.
Meanwhile, when the +DI line is greater than the –DI line, it only suggests that the bulls have the directional edge. However, when the –DI line is greater than the +DI, it only suggests that the bears have the directional edge.
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