It is much more complex to form than other oscillators. First, pressure indicators to buy (+DM) and sell (-DM) are identified. These pressures are then expressed as a percentage of the maximum variation of the market on the period, and a moving average of these indicators is calculated, respectively +DMI and –DMI.
Let us take the example of a 14-day period, with +DMI14 = 0.2 and –DMI = 0.36. This means that 20 % of the market range in the past 14 days was done on the upside and 36 % on the downside. On this range, 56 % (0.2 + 0.36) was directional.
Thus, the more directional the market (on the upside AND on the downside), the greater the sum of the DMIs (DMI sum). Still, the difference between +DMI and –DMI is more often calculated (DI diff). The information given on the trend is then different: the higher this difference, the more directional the market in the same direction. The DI diff / Di sum ratio, expressed as a percentage, then gives DX, which is smoothened on the period (often 14 days) to form ADX.
Once these oscillators are built, it becomes quite easy to use them. First, one can compare the respective positions of +DMI and –DMI. If +DMI stands above –DMI, the trend on the upside is strong, which means that buyers win more and more. In opposition, if +DMI stands under – DMI, this is the trend on the downside which is strong, and the sellers then become the winners.
Moreover, signals are also given by the ADX. As this latter bypasses 17, the market is considered as following a trend. It is then possible to buy (+DMI above –DMI) or sell (-DMI above +DMI).
Finally, the ADX enables one, along with moving averages, to determine the validity of the latter. Indeed, as moving averages sometimes have false signals, it is possible to buy only when the ADX shows a trend, and then to follow signals given by moving averages.
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