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The ADX Indicator, otherwise known as Directional Movement Index.
The ADX is a trend following system. The average directional
movement index, or ADX, determines the market trend. When used
with the up and down directional indicator values, +DI and -DI,
the DMI is an exact trading system.
The standard interpretation for using the ADX is to establish a
long position whenever the +DI crosses above the -DI. You reverse
that position, liquidate the long position and establish a short
position, when the -DI crosses above the +DI.
In our custom charts the ADX is the red line, the -DI is the green
line and the +DI is the blue line.
In addition to the crossover rules, you must also follow the
extreme point rule. When a crossover occurs, use the extreme
price as the reverse point. For a short position, use the high
made during the trading interval of the crossover. Conversely,
reverse a long position using the low made during the trading
interval of the crossover.
You maintain the reverse point, the high or low, as your market
entry or exit price even if the +DI and the -DI remain crossed
for several trading intervals. This is supposed to keep you from
getting whipsawed in the market.
For some traders, the most significant use of the ADX is the
turning point concept. First, the ADX must be above both DI
lines. When the ADX turns lower, the market often reverses the
current trend. The ADX serves as a warning for a market about to
change direction. The main exception to this rule is a strong
bull market during a blow-off stage. The ADX turns lower only to
turn higher a few days later.
According to the developer of the DMI, you should stop using any
trend following system when the ADX is below both DI lines. The
market is in a choppy sidewise range with no discernible trend.
If you need further explanation, please refer to the author's
original work. The book titled New Concepts in Technical Trading
Systems by J. Welles Wilder, Jr. explains this indicator and
several others.