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Technical Indicators: A (part 4)
Average Directional Movement Index
Developed by J. Welles Wilder, the Average Directional Movement Index (ADX) is an indicator for use with the Directional Movement Index and quantifies the strength and direction of a trend. The ADX consists of three components: the plus Directional Indicator (+DI), the minus Directional Indicator (-DI) and the Average Directional Indicator. The ADX is simply a modified moving average of DX.
To calculate up or down directional movement in a trend, a range is determined by comparing today's high and low with yesterdays close. If the largest part of today's range is above yesterday's range, the directional movement is plus. If the largest part of today's range is below yesterday's range, the directional movement is minus. If today's range is within yesterday's range, then directional movement is defined as zero. The average of the directional movement indicators is the ADX.
Read the ADX like an oscillator. A high positive value would be bullish. A low negative value is interpreted as bearish.
See also: Directional Movement Index
Average Directional Movement Index Rating
The Average Directional Movement Index Rating (ADXR) is an attempt to quantify momentum change in the ADX. It is calculated by adding the current ADX value and an ADX value n periods back then dividing that sum by two.
This smoothing step results in the ADXR being slightly less responsive than the ADX. Where the ADXR shines is its ability to compensate for the variance of excessive tops and bottoms. It is especially helpful when used in conjunction with trend-following strategies. Strategies that rely on volatility as an indication of movement often fail to take into account movement does not necessarily indicate volatility. ADXR provides information pertaining to the strength of a trend, helping to manage the risk of trading in volatile markets that fluctuate between trending and non-trending. The interpretation of ADXR is the same as that for ADX, the higher the value, the stronger the trend.
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Average True Range (ATR)
Average True Range or ATR is a measurement of volatility. It measures the average of true price ranges over time. The True Range is the greatest distance between today's high to today's low, yesterday's close to today's high, or yesterday's close to today's low. The Average True Range is a moving average of the True Ranges.
High ATR values often occur at market bottoms following a "panic" sell-off. Low Average True Range values are often found during extended sideways movement, like as those found at market tops or after consolidation periods. True Range is used in Welles Wilder's Directional Movement indicator as well as Donald Mart's Master Trading Formula and is a common volatility ratio. The ATR can be used in a channel breakout method of trading by adding or subtracting from the previous bar's close or the current bar's open.
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