Using the Average Directional Index Indicator (ADX) in Spread Betting

The Average Directional Index is one of the oldest indicators used to identify whether the price of a financial instrument is trending or oscillating.

The ADX is range bound, oscillating between 0 and 100. The higher the level of the ADX indicator, the stronger the trend. Its calculation is fairly complex but it essentially compares price ranges. If the price ranges of subsequent days are larger than the previous days then the ADX rises indicating a strong trend

The ADX line itself does not indicate the direction of the trend, only its strength. Values above 30 on the ADX graph are considered to be indicators of a strong trend. The higher the value the stronger the trend. When it rising it indicates a gather price momentum in the direction of the trend and bets should only be made in the direction of the trend. Readings above 40 signify a strong trend although readings above 60 tend to be quite uncommon.

By identifying whether the market is trending or choppy in this way a spread bettor can adopt the relevant trading strategy.

The ADX is calculated from two other indicators, the Positive Directional Indicator (+DI) and the Negative Directional Indicator (-DI). ADX is the difference between these two line.

Trend Direction

The ADX will signify the strength of the trend but not the direction. We can however define a trend by the position of the +DI and -DI relative to one another. A +DI above -DI indicates a buy signal and vice-versa for a sell. This should be confirmed either by visual inspection of the charts in both the current and larger time frames or by using moving averages.

In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI.

In Figure 1. below the green line on the candlestick chart is the 21 day simple moving average and in the section along the black arrow the price is clearly seeing a downtrend. The chart below it shows the ADX as a solid blue line.

During this period the ADX gives a strong reading above 30 until the start of July where the price start to flatten out and revert to a choppier pattern. At this time the ADX falls and moves below 20 supporting the fact that the trend has ended. Also note that the red dotted -DI line is above the black dotted +DI line during the down trend.

Figure 1.

Because the ADX is a lagging indicator the message it conveys is delayed. This doesn't stop it being a very useful indicator for identifying trends and also identifying when trends might be over. It should be used in conjunction with other indicators and is certainly not designed as a tool to trigger trades.