Table of contents:
- 1 Oscillator to measure trend strength
- 1.1 Signals in the ADX-Indicator
- 1.2 Concrete benefits of the ADX?
- 1.3 Calculation of the ADX with EXCEL
- 1.4 Calculating the “true range” with EXCEL
- 1.5 Calculation -DM and +DM
- 1.6 14-day sums “true range” and -DM(14) +DM(14)
- 1.7 +DI(14), -DI(14) and DX
- 1.8 Calculation ADX, signal strength and interpretation
The ADX (Average Directional Movement Index) is designed to show the development of trend strength and is therefore used as a filter for sideways movements in many automated trading systems. To understand the ADX, however, it is important to understand what the ADX can and cannot do. One should also not overlook the fact that the ADX, as one of the rather older indicators, cannot work miracles.
Oscillator to measure trend strength
In general, the literature indicates that an ADX below 30 indicates a sideways trend, an ADX below 15 even indicates strong “investment pressure”. ADX levels below 15 therefore warn of a situation that could lead to a violent movement in one direction or the other. It takes getting used to the fact that the ADX does not indicate the direction of the trend, but only the extent of the movement!
Signals in the ADX-Indicator
In the diagram above I have drawn six phases which should show the strengths and weaknesses of the ADX.
In phase -1- the ADX is below 30, so you can assume a sideways trend. Signals from the trend-following indicators such as MACD and Momentum should therefore be taken with caution, while oscillators (such as Stochastics for example) are more appropriate.
The beginning downtrend in phase -2- leads to a rising ADX, whereas the actual sell-signal was generated by the break of the sideways-trend. The rising ADX is not to be understood as a sell-signal, only as a confirmation.
In phase -3- we experience a bottom formation with rising prices. The signal is good in the ADX, which shows the nascent weakness of the downtrend by a top formation. Bad is that the ADX suffers from too much delay! While the Nikkei rises by almost 1,000 points, the ADX falls below thirty and rather indicates a sideways trend, since the ADX initially still fully includes the downward trend in its calculation.
In phase -4- a new downward trend begins. The ADX reacts very slowly again and initially falls below thirty, although the NIKKEI loses almost 1,500 points.
Phase -5- is successful. The downward trend continues, the ADX shows the trend strength. With a divergence at the end of the movement even the recovery is indicated.
In phase -6- the ADX falls back to fifteen. The downtrend changes into a volatile sideways movement. Investment pressure is built up: it is very possible that a significant upward movement is imminent.
The example shows that the ADX always reacts with a certain delay. Since more than fourteen trading days of data are generally used for the ADX(14), a successful turnaround after seven rising days, for example, may still include more than seven falling days in the ADX! This delay is a major problem when using the ADX.
Concrete benefits of the ADX?
But the ADX also has its good sides! In the chart above we have a nice divergence between the index and the ADX in phase -1-. While the DAX is still setting new highs, the ADX is already falling. Phase -2- again shows the main problem of the ADX: the steep downward trend is shown, the equally steep upward trend is not yet fully processed in the ADX even at its end! Only the sideways phase -3- is displayed clearly. For a trading system, however, the ADX is worth its weight in gold! in phase -1- and -2- trend followers like the MACD and Momentum will have done a good job while in phase -3- an oscillator can show its strengths!
Calculation of the ADX with EXCEL
The calculation of the ADX is relatively complex. The necessary calculations are explained in detail below, step by step, using an EXCEL table.
Calculating the “true range” with EXCEL
Columns A, B, C, D, E and F contain the price data from line 3 onwards in the order of date, open, high, low, close and turnover.
Column G contains the “true range” for one day. This is calculated using the formula
Calculation -DM and +DM
The H and I columns contain the value for -DM and +DM. The calculation is performed for -DM with:
and for the +DM with:
14-day sums “true range” and -DM(14) +DM(14)
The columns J, K and L are now filled with the “true range 14”, the -DM(14) and +DM(14) from line 17. The cells in J, K and L thus contain the sum of the fourteen rows G, H and I before.
In row 17, the columns J, K, and L have the following contents:
In line 18, the columns J, K and L have the following contents (etc.):
+DI(14), -DI(14) and DX
From line 17 onwards, the columns M to Q are also filled.
These columns contain, in order, the +DI14, -DI14, the absolute difference between +DI14 and -DI14, the sum of +DI14 and -DI14, and the DX.
The cells in row 17 are therefore filled as follows:
Cell M17: =(100(K17/J17)) Cell N17: =(100(L17/J17))
Cell O17: =ABS(M17-N17)
Cell P17: =M17+N17
Cell Q17: =(100*(O17/P17))
Calculation ADX, signal strength and interpretation
From line 30 on, the actual ADX can now be calculated.
Cell R17 is filled with the following: = AVERAGE(Q17:Q30)
If you want, you can also get a hint for the interpretation in the columns S and T. The ADX is considered “strong” if it is above 30 points.
Cell S17: =WENN(R30=””;””;WENN(R30>=30; “strong”; “weak”)
Whether the ADX is “bullish” can be formulated in column T17 as follows
Cell T17: = IF(R30=””;””;IF(M30>N30; “Bullish”; “Bearish”))