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ADX: How strong is this market?

Key takeaways

  • Average directional index (ADX) is a short-term chart indicator.
  • It can be used to help you evaluate the market or an investment's strength.
  • ADX currently suggests the short-term momentum behind stocks may be strong, with a caveat.

It's understandable to look at this market and think that it's strong. After all, multiple global indexes are trading at or near all-time highs, including the US.

If you are an active investor, you might be wondering just how strong the rally is. That's where ADX, a chart indicator that helps measure the strength of a trend, may shed some light. According to ADX, this bull market rally may have momentum to continue.

How strong are stocks now?

Whereas other chart indicators can help you determine at what price to buy and sell a stock, ADX is used to help determine how strong a trend is. Trend strength can be important as it can help determine if there is momentum behind a market move.

To understand why, consider a hypothetical stock that is rising in price. Would you rather own this stock if the uptrend were strengthening or weakening? From a technical analysis perspective, a rising stock in a strong uptrend may suggest greater likelihood of continuing to rise than the same stock whose uptrend is showing signs of weakness.

ADX is a short-term indicator that can be used under any type of market conditions (e.g., bull or bear markets, high or low volatility, etc.). It is simply the mean, or average, of the values of directional movement (DM) lines over a specified period. DM lines are calculated using current high and low prices.

The bottom part of the chart below demonstrates what the ADX indicator looks like. It also shows that stocks have been in an uptrend since October 2023, and in a secular (i.e., long-term) uptrend since this bull market began in October 2022.

ADX indicator and the S&P 500

The data in the chart is described in the text.
Source: Active Trader Pro®, as of March 21, 2024.

Much like RSI and stochastics, ADX fluctuates between 0 and 100. Unlike other technical indicators, ADX readings above 60 do not occur frequently. In practice, most chart analysts believe a reading above 25 typically indicates a strong trend and a reading below 20 usually suggests there is no trend—with no clear signal interpretation existing between 20 and 25. Currently, ADX (the orange line) is near 27, which suggests a strong trend.

A rising ADX line generally means that an existing trend is strengthening. If ADX suggests the trend is strong (i.e., ADX is rising), then trend-following systems—such as moving averages and channel breakouts—are expected to have more validity. Alternatively, if you see a falling ADX line, which indicates an existing trend is weak or there is no trend, you may not want to place as much value in the signals given by trend-following systems. While stocks have been rising to new all-time highs, the ADX line has actually been trending lower recently, suggesting the uptrend may be exhibiting some short-term weakness. It could be worth watching to see if the ADX line continues to trend lower and subsequently falls below 25.

There are actually 3 lines in the ADX indicator. The most important one is the ADX line. In addition, there are 2 other lines: A DMI plus line (sometimes shown on charts as DMI+ or DI+) and a DMI minus line (sometimes shown on charts as DMI- or DI-). DMI stands for directional movement indicator. Whereas the ADX line determines the strength of the trend, the 2 DMI lines complement the ADX line by helping determine the trend's direction.

The direction of the trend is interpreted as positive when the DMI plus line is higher than the DMI minus line. Conversely, the direction of the trend is interpreted as negative when the DMI minus line is higher than the DMI plus line. Based on the DMI plus line currently being higher than the DMI minus line, this confirms the direction of the trend as positive, based solely on this indicator.

How to use ADX

Indicators like ADX can be useful supplements to your overall investing outlook that should be based primarily on fundamentals of the global economy, the business cycle, and any other relevant factors. ADX is painting a mostly bullish picture, with a potentially conflicting signal, and readings over the near term could provide insight into the strength of this bull market.

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Technical analysis focuses on market action — specifically, volume and price. Technical analysis is only one approach to analyzing stocks. When considering which stocks to buy or sell, you should use the approach that you're most comfortable with. As with all your investments, you must make your own determination as to whether an investment in any particular security or securities is right for you based on your investment objectives, risk tolerance, and financial situation. Past performance is no guarantee of future results.

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.

Indexes are unmanaged. It is not possible to invest directly in an index.

Past performance is no guarantee of future results.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

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