ADX is a lagging indicator that measures the trend strength without regard to trend direction.
ADX is formed by combining two other indicators which are positive directional indicator (abbreviated +DI) and negative directional indicator (abbreviated -DI). Positive Directional Indicator is calculated based on differences between current high and previous high over recent trading periods. Similarly Negative Directional Indicator is calculated based on differences between current low and previous low over certain recent trading periods.
ADX will range between 0 and 100 and is usually calculated based on 14 time-periods. Usually 20 is used as the key level for analysing ADX.
Since ADX enables one to quantify trend strength, it helps to identify the strongest trends as well as range conditions. So, appropriate trading strategy can be used. In trending conditions, one can enter on pullbacks and trade in direction of the trend where as in range conditions, one can trade on reversal either at support (bullish) or at resistance (bearish). In range conditions, another strategy can be to combine ADX with RSI (overbought and oversold) signal.
Different researchers have come out with various ways to interpret ADX. Some of the popular ones are as below:
Note: ADX or +DI/-DI based signals are frequently generated and have to be filtered, that is, they are to be confirmed using other indicators such as volume based indicators, basic trend analysis such as based on Moving Average (MA) Indicators and Chart patterns.