Those who are serious stock market investors are always trying to find out patterns and trends in the way the prices fluctuate so that they are able to correctly predict the next movements and make the right investment decisions. The ADX or the Average Directional Movement Index is a tool that helps in the technical analysis of a stock so that the investors can find out the price trend. This is accomplished with the help of Directional Movement Lines (DMI) – the minus DMI line, the plus DMI line and the ADX line (Average Directional Movement). The calculation goes as follows: ADX = SUM[(+DI-(-DI))/(+DI+(-DI)), N]/N. In this, ‘N’ signifies the period that is considered for the calculation. However the investor needs to know here that the ADX is used to find out the strength of the trend and not the direction of the trend.

To calculate the DMI, the UpMove is determined by subtracting today’s high from yesterday’s high (Today’s High − Yesterday’s High), and the DownMove is calculated by subtracting Yesterday’s Low from Today’s Low (Yesterday’s Low − Today’s Low).

Directional Movements And The ADX

It has to be kept in mind that the ADX is relevant not just with little movements far and between. Rather, it tries to identify sustained movements over time in any one direction and that too, its strength. Using the index, an investor or the analyst can come to a conclusion about the trend when the ADX either goes below or higher a certain level. And not just the trend, the ADX is also able to predict when a trend is coming to an end. This can be predicted when it is observed that the ADX line goes above 40 and then takes a downturn.

Though it is often very useful, but frankly, the Average Directional Movement Index is not used as much as some other technical indicators in the stock market. But the fact remains that the ADX does indeed come with certain advantages. For example, it is able to filter out many of the false alarms such as random price oscillations. So there are definite advantages for the trader if the person uses the index to take decisions in the market.

The Average Directional Movement Index is a brainchild of Welles Wilder who came out with this tool in the book “New concepts in technical trading systems”.

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