ADX Trading Strategy (Average Directional Movement Index Indicator) – Statistics, Facts And Historical Backtests!

Is it possible to use the ADX indicator (Average Directional Movement Index) (DMI) to find a profitable ADX trading strategy? This article looks at the ADX indicator where we make some historical backtest to evaluate and analyze. The adx indicator was developed by Welles Wilder and released in his book in 1978 called New Concepts In Technical Trading Systems. Mr. Wilder was productive, and in the same book, he published perhaps the most used indicator of them all, the relative strength index (RSI), in addition to the average true range (ATR), and parabolic SAR. The book was written before the personal computer came about, but all the indicators are widely used to this very day.

There are many ways to use the ADX in trading strategies. Our research and backtests indicate the ADX indicator is somewhat useful on its own but adds great value used alongside other indicators when you build trading strategies. In this article, we look at how the Average Directional Movement performs alongside other indicators, and we test some ADX trading strategies.

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What is the ADX indicator?

Mr. Wilder aimed to make a formula that measures the trend and the strength of the trend. He came up with the ADX indicator, an abbreviation for Average Directional Movement Index but is known as the ADX indicator.

The aim of the ADX indicator is to measure the underlying trend of the instrument. Unfortunately, Wilder’s book is out of print, but we are unsure if Wilder made the indicator a stand-alone indicator or used it together with other indicators. As you will see later in the article, we prefer to use it as a supplement to other indicators.

We must keep in mind that Wilder was a commodity trader, and the indicator was meant for swing trading in commodity futures, but it seems to work in more or less any instrument.

The ADX indicator involves many mathematical calculations and is, of course, very cumbersome to do by hand. Luckily we have computers, and most trading platforms have ADX as a standard indicator, which you can drop on the chart.

The indicator consists of three components:

• The Plus Direction Indicator (DI+)
• The Minus Direction Indicator (DI-)
• The ADX measures the strength of the trend based on the two above

The Plus and Minus Direction Indicators are referred to as the Directional Movement Indicators (DM). Please be aware that the indicator doesn’t indicate the direction of the trend, only the trend’s strength.

When the DI+ is rising, it means the uptrend gains momentum, and vice versa for the DI-. The DM is the absolute difference between the two readings and thus doesn’t say anything about the trend’s direction.

What does the ADX indicate?

By combining these three indicators above, Mr. Wilder both measures the direction of the trend and the trend’s strength (or the lack of a trend).

A high reading indicates a trending market, and a low reading indicates a non-trending market. The ADX was thus originally made as a trend indicator.

As with all indicators, it’s a lagging indicator. This means an uptrend or downtrend is confirmed when it’s already established. The ADX operates in a range from 0 to 100.

The shorter the time frame, the more volatile the ADX. If you use time frames longer than ten days, you will notice the ADX rarely goes above 50, more or less in any market. What does this mean? Most markets are not trending.