The average directional movement index (A.D.X.) was developed in 1978 by J. Welles Wilder as an indicator of trend strength in a series of prices of a financial instrument. A.D.X. has become a widely used indicator for technical analysts, and is provided as a standard in collections of indicators offered by various trading platforms.
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Calculations
The A.D.X. is a combination of two other indicators developed by Wilder, the positive directional indicator (abbreviated +DI) and negative directional indicator (-DI). The A.D.X. combines them and smooths the result with a smoothed moving average.
To calculate +DI and -DI, one needs price data consisting of high, low, and closing prices each period (typically each day). One first calculates the directional movement (+DM and -DM):
After selecting the number of periods (Wilder used 14 days originally), +DI and -DI are:
The smoothed moving average is calculated over the number of periods selected, and the average true range is a smoothed average of the true ranges. Then:
Variations of this calculation typically involve using different types of moving averages, such as an exponential moving average, a weighted moving average or an adaptive moving average.
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Interpretation
The A.D.X. does not indicate trend direction or momentum, only trend strength. It is a lagging indicator; that is, a trend must have established itself before the A.D.X. will generate a signal that a trend is under way. A.D.X. will range between 0 and 100. Generally, A.D.X. readings below 20 indicate trend weakness, and readings above 40 indicate trend strength. An extremely strong trend is indicated by readings above 50. Alternative interpretations have also been proposed and accepted among technical analysts. For example it has been shown how A.D.X. is a reliable coincident indicator of classical chart pattern development, whereby A.D.X. readings below 20 occur just prior to pattern breakouts.
Timing
Various market timing methods have been devised using A.D.X.. One of these methods is discussed by Alexander Elder in his book Trading for a Living. According to Elder, there is a buy signal when the A.D.X. peaks and starts to decline when the +DI is above the -DI. With this strategy you would sell when the A.D.X. stops falling and goes flat.
Source of the article : Wikipedia
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