Average Directional Index (ADX)
Measures the strength of a trend regardless of its direction.
The average directional index (ADX) measures the strength of a trend on a scale from 0 to 100, without indicating direction. It does not tell you if a stock is going up or down — it tells you how strongly it is trending in either direction. ADX is derived from two directional movement indicators (+DI and -DI) and is typically plotted with a 14-period lookback. A rising ADX means a trend is strengthening. A falling ADX means the trend is weakening.
Why It Matters
Knowing whether a stock is trending or ranging changes everything about your options strategy. In a strong trend, directional strategies like vertical spreads and naked options thrive. In a range-bound market, premium-selling strategies like iron condors and strangles are more appropriate. ADX is the definitive tool for making this distinction.
Many traders lose money by applying trending strategies in sideways markets or range-bound strategies in trending markets. ADX prevents this mismatch. Before selecting your options strategy, check ADX to understand the market regime — then choose the right tool for the job.
How It Works
Calculation overview:
- Calculate +DM and -DM (directional movement) based on current and previous highs and lows.
- Smooth these values over 14 periods and divide by ATR to get +DI and -DI.
- ADX = 14-period smoothed average of the absolute difference between +DI and -DI, divided by their sum.
Key levels:
- ADX below 20: Weak trend or no trend. The stock is range-bound. Favor neutral strategies — iron condors, butterflies, calendar spreads.
- ADX 20 to 40: Moderate trend. Directional strategies can work but manage risk carefully.
- ADX above 40: Strong trend. Directional strategies have high conviction. Trend-following approaches thrive.
- ADX above 60: Extremely strong trend (rare). Major moves are in play.
Using +DI and -DI for direction:
- When +DI is above -DI, the trend direction is bullish.
- When -DI is above +DI, the trend direction is bearish.
- A +DI crossover above -DI with rising ADX is a strong bullish signal. The reverse is a strong bearish signal.
ADX turning points:
- ADX rising from below 20 to above 20: A new trend may be emerging. Watch for directional breakouts.
- ADX falling from above 40: The trend is losing steam. Profits from directional trades should be protected or taken.
Limitations: ADX is a lagging indicator that takes time to register a trend change. By the time ADX confirms a strong trend, the move may already be well underway. Use it as a filter for strategy selection rather than a timing tool.
Quick Example
You are considering selling an iron condor on a stock trading at $200. You check ADX and it reads 15 with no clear direction in +DI/-DI. This confirms a range-bound market — ideal for an iron condor. You sell the spread and collect premium while the stock chops sideways. Had ADX been at 45, you would have avoided the iron condor and looked for a directional trade instead.