The DMI indicator

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How to Trade With the Directional Movement Index (DMI)

Using DMI to Identify Uptrends and Downtrends With Strength

The Directional Movement Index (DMI) is a momentum indicator that was developed by J. Welles Wilder. The DMI is part of a series of technical indicators developed by Wilder, and some trading platforms split up the indicators, providing the Directional Movement as one indicator and the Average Direction Index (ADX) as another. Typically, these indicators are used together to form the DMI. Directional Movement shows whether the downside or upside movement is stronger, and ADX shows the strength of that movement.

Directional Movement Index Basics

The DMI is a technical indicator that is typically shown below or above the price chart and is calculated by comparing the current price with the previous price range. DMI then displays the result as an upward directional index (+DI) and a downward directional index (-DI). The DMI also calculates the strength of the upward or downward movement and displays the result as a trend strength line called Average Directional Index or ADX.

+DI and -DI show up as two separate lines, colored green and red, respectively. When the red line is above the green line, it means the price is dropping. When the green line is above the red line, it means the price is rising. If the -DI and +DI are crisscrossing back and forth, there likely isn’t a price trend going on, and the price is moving sideways.

ADX is a third line on the indicator, and it shows the strength of the trend. So while the -DI and +DI help highlight direction, ADX focuses on how strong the uptrend or downtrend is. An ADX reading above 25 signals a strong trend is in place. When the ADX is oscillating below 25, it usually means there isn’t a strong trend, and the price is moving sideways or within a weak trend.

The attached chart shows a one-minute chart with ADX and Directional Movement lines. The indicators are separated to avoid clutter, but it is possible (and common) to have the ADX, -DI, and +DI all shown in one window instead of two. The indicators can also be used separately, though. Some traders may only choose to view the ADX for trend strength, while others may prefer only viewing the Direction Movement lines to aid in confirming price direction.

Directional Movement Index Trading Uses

The DMI can be used in both ranging and trending markets. In general, when the +DI line is above the -DI line, the market is moving upwards, and when the -DI line is above the +DI line, the market is moving downwards. When trading a trending strategy, favor long positions when the +DI is above the -DI line, and try to avoid long trades when the -DI is above the +DI. When the -DI is above the +DI, favor short positions, and avoid taking short positions when the +DI is above the -DI.

The market is considered to be trending when the ADX line is above 25, and ranging when the ADX line is below 25. Many traders also consider an ADX reading above 20 as trending, and below 20 as non-trending. Used in conjunction with the Directional Movement uses discussed above, ADX can further filter or confirm trade signals. If trading a trending strategy, the ADX should ideally be above 20 (or 25) for taking trades in potential uptrends or downtrends. For trading strategies that trade ranges (sideways movement), then ADX should be below 20 (or 25).

DMI Points the Way to Profits

The primary objective of the trend trader is to buy or sell an asset in the direction of the trend. Reading directional signals from the asset’s price alone can be difficult and is often misleading because price normally swings in both directions and changes character between periods of low versus high volatility.

The directional movement indicator (also known as the directional movement index or DMI) is a valuable tool for assessing price direction and strength. It was created in 1978 by J. Welles Wilder, who also created the popular relative strength index (RSI). The DMI is especially useful for trend trading strategies because it differentiates between strong and weak trends, allowing the trader to enter only the ones with real momentum. DMI works on all time frames and can be applied to any underlying vehicle (stocks, mutual funds, exchange-traded funds, futures, commodities, and currencies).

While its calculations are somewhat complicated, DMI tells you when to be long or short. Here, we’ll cover how to analyze the DMI indicator in detail and show you what information it can reveal to help you achieve better profits.

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DMI Trend Lines

DMI is a moving average of range expansion over a given period (the default is 14 days). The positive directional movement indicator (+DMI) measures how strongly price moves upward; the negative directional movement indicator (-DMI) measures how strongly price moves downward. The two lines reflect the respective strength of the bulls versus the bears.

Each DMI is represented by a separate line (see Figure 1). First, look to see which of the two DMI lines is on top. Some short-term traders refer to this as the dominant DMI. The dominant DMI is stronger and more likely to predict the direction of price. For the buyers and sellers to change dominance, the lines must cross over.

A crossover occurs when the DMI on bottom crosses up through the dominant DMI on top. Crossovers may seem like an obvious signal to go long/short, but many short-term traders will wait for other indicators to confirm the entry or exit signals to increase their chances of making a profitable trade. Crossovers of the DMI lines are often unreliable because they frequently give false signals when volatility is low and late signals when volatility is high. Think of crossovers as the first indication of a potential change in direction.

Figure 1. Source: TD Ameritrade Strategy Desk

In Figure 1, the +DMI and -DMI are shown as separate lines. There are several false crossovers (Point 1) and one crossover at Point 2 that leads to an uptrend with +DMI dominant. (Note: DMI is normally plotted in the same window with the ADX indicator, which is not shown.)

DMI Directional Signals

DMI is used to confirm price action (see Figure 2). The +DMI generally moves in sync with price, which means the +DMI rises when price rises, and it falls when price falls. It is important to note that the -DMI behaves in the opposite manner and moves counter-directional to price. The -DMI rises when price falls, and it falls when price rises. This takes a little getting used to. Just remember that the strength of a price move up or down is always recorded by a peak in the respective DMI line.

Reading directional signals is easy. When the +DMI is dominant and rising, price direction is up. When the -DMI is dominant and rising, price direction is down. But the strength of price must also be considered. DMI strength ranges from a low of 0 to a high of 100. The higher the DMI value, the stronger the prices swing. DMI values over 25 mean price is directionally strong. DMI values under 25 mean price is directionally weak.

Figure 2. Source: TD Ameritrade Strategy Desk

In Figure 2, the DMI is weak at Point 1 and price is choppy. The +DMI rises strongly above 25 at Point 2 and the uptrend follows. Note how +DMI moves with price at Point 3 and -DMI moves counter-directional to price at Point 4.

DMI Momentum

The great feature of DMI is the ability to see buying and selling pressure at the same time, allowing the dominant force to be determined before entering a trade. The strength of a swing high (bulls) is reflected in the +DMI peak, and the strength of a swing low (bears) is seen in the -DMI peak. The relative strength of the DMI peaks tells the momentum of price and provides timely signals for trading decisions. When the buyers are stronger than the sellers, the +DMI peaks will be above 25 and the -DMI peaks will be below 25. This is seen in a strong uptrend. But when the sellers are stronger than the buyers, the -DMI peaks will be above 25 and the +DMI peaks will be below 25. In this case, the trend will be down.

The ability of price to trend depends on continued strength in the dominant DMI. A strong uptrend will show a series of rising +DMI peaks that remain above the -DMI for extended periods of time (Figure 3). The opposite is true for strong downtrends. When both DMI lines are below 25 and moving sideways, there is no dominant force, and trend trades are not appropriate. However, the best trends begin after long periods where the DMI lines cross back and forth under the 25 level. A low-risk trade setup will occur after DMI expands above the 25 level and price penetrates support/resistance.

Figure 3. Source: TD Ameritrade Strategy Desk

In Figure 3, the +DMI crosses above 25 at Point 1 and remains above the -DMI as the uptrend develops. Note the absence of any crossover by -DMI during the uptrend. Here, the buyers are strong (+DMI >25) and the sellers are weak (-DMI DMI Pivots

DMI lines pivot, or change direction, when price changes direction. An important concept of DMI pivots is they must correlate with structural pivots in price. When price makes a pivot high, the +DMI will make a pivot high. When price makes a pivot low, the -DMI will make a pivot high (remember, -DMI moves counter-directional to price).

The correlation between DMI pivots and price pivots is important for reading price momentum. Many short-term traders watch for the price and the indicator to move together in the same direction or for times they diverge. One method of confirming an asset’s uptrend is to find scenarios when price makes a new pivot high and the +DMI makes a new high. Conversely, a new pivot low combined with a new high on the -DMI is used to confirm a downtrend. This is generally a signal to trade in the direction of the trend or a trend breakout.

Divergence, on the other hand, is when the DMI and price disagree, or do not confirm one another. An example is when price makes a new high, but the +DMI does not. Divergence is generally a warning to manage risk because it signals a change of swing strength and commonly precedes a retracement or reversal.

Figure 4. Source: TDAmeritrade Strategy Desk

Figure 4 shows an example of when the price and indicator agree (Point 1), where price makes a new high and +DMI makes a new high, signaling a long entry. There is also an example of divergence (Point 2), where price makes a new high and the +DMI, though it rises, does not; the result is a trend retracement at Point 3.

DMI and Price Volatility

The DMI lines are a good reference for price volatility. Price goes through repeated cycles of volatility in which a trend enters a period of consolidation and then consolidation enters a trend period. When price enters consolidation, the volatility decreases. Buying pressure (demand) and selling pressure (supply) are relatively equal, so the buyers and sellers generally agree on the value of the asset. Once the price has contracted into a narrow range, it will expand as the buyers and sellers no longer agree on price. Supply and demand are no longer in balance, and consolidation changes to trend when price breaks below support into a downtrend or above resistance into an uptrend. Volatility increases as price searches for a new agreed value level.

Volatility cycles can be identified by comparing the slopes of the DMI lines that move in opposite directions whenever range expansion or contraction occurs (Figure 4). Many short-term traders will look for periods when the DMI lines move away from one another and volatility increases. The farther the lines separate, the stronger the volatility. Contractions occur when the lines move toward one another and volatility decreases. Contractions precede retracements, consolidations, or reversals.

Figure 5.Source: TD Ameritrade Strategy Desk

In Figure 5, the first expansion at Point 1 is part of the downtrend. The subsequent contraction at Point 2 leads to a reversal that begins with another expansion at Point 3. The next contraction at Point 4 leads to a consolidation in price.

The Bottom Line

DMI peak analysis fits well with trend principles. An asset’s price is trending up when there are higher pivot highs and higher pivot lows. When higher highs in price are accompanied by higher highs in +DMI, the trend is intact and the bulls are getting stronger. Lower pivot highs and lower pivot lows signify a downtrend. When the -DMI peaks make higher highs, the bears are in control and selling pressure is getting stronger. Looking to the DMI for momentum convergence/divergence gives you the confidence to stay with the trend when price and DMI agree and manage risk when they disagree.

The best trading decisions are made on objective signals and not emotion. Let price and DMI tell you whether to go long, go short, or just stand aside. You can use DMI to gauge the strength of price movement and see periods of high and low volatility. DMI contains a wealth of information that can identify the correct strategy for profit, whether you are a bull or bear.

Average Directional Index – ADX Definition and Uses

What is the Average Directional Index (ADX)?

The average directional index (ADX) is a technical analysis indicator used by some traders to determine the strength of a trend. The trend can be either up or down, and this is shown by two accompanying indicators, the Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI). Therefore, ADX commonly includes three separate lines. These are used to help assess whether a trade should be taken long or short, or if a trade should be taken at all.

Key Takeaways

  • Designed by Welles Wilder for commodity daily charts, but can be used in other markets or other timeframes.
  • The price is moving up when +DI is above -DI, and the price is moving down when -DI is above +DI.
  • Crosses between +DI and -DI are potential trading signals as bears or bulls gain the upper hand.
  • The trend has strength when ADX is above 25. The trend is weak or the price is trendless when ADX is below 20, according to Wilder.
  • Non-trending doesn’t mean the price isn’t moving. It may not be, but the price could also be making a trend change or is too volatile for a clear direction to be present.

The Formulas for the Average Directional Index

(ADX) Indicator are

The ADX requires a sequence of calculations due to the multiple lines in the indicator.

Calculating the Average Directional Movement Index (ADX)

  1. Calculate +DM, -DM, and True Range (TR) for each period. 14 periods are typically used.
  2. +DM = Current High – Previous High.
  3. -DM = Previous Low – Current Low.
  4. Use +DM when Current High – Previous High > Previous Low – Current Low. Use -DM when Previous Low – Current Low > Current High – Previous High.
  5. TR is the greater of the Current High – Current Low, Current High – Previous Close, or Current Low – Previous Close.
  6. Smooth the 14-period averages of +DM, -DM, and TR. The TR formula is below. Insert the -DM and +DM values to calculate the smoothed averages of those.
  7. First 14TR = Sum of first 14 TR readings.
  8. Next 14TR value = First 14TR – (Prior 14TR/14) + Current TR
  9. Next, divide the smoothed +DM value by the smoothed TR value to get +DI. Multiply by 100.
  10. Divide the smoothed -DM value by the smoothed TR value to get-DI. Multiply by 100.
  11. The Directional Movement Index (DX) is +DI minus -DI, divided by the sum of +DI and -DI (all absolute values). Multiply by 100.
  12. To get the ADX, continue to calculate DX values for at least 14 periods. Then, smoothe the results to get ADX
  13. First ADX = sum 14 periods of DX / 14
  14. After that, ADX = ((Prior ADX * 13) + Current DX) /14

What Does the Average Directional Index (ADX) Tell You?

The Average Directional Index (ADX) along with the Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI) are momentum indicators. The ADX helps investors determine trend strength while -DI and +DI help determine trend direction.

The ADX identifies a strong trend when the ADX is over 25 and a weak trend when the ADX is below 20.

Crossovers of the -DI and +DI lines can be used to generate trade signals. For example, if the +DI line crosses above the -DI line and the ADX is above 20, or ideally above 25, then that is a potential signal to buy.

If the -DI crosses above the +DI, and ADX is above 20 or 25, then that is an opportunity to enter a potential short trade.

Crosses can also be used to exit current trades. For example, if long, exit when the -DI crosses above the +DI.

When ADX is below 20 the indicator is signaling that the price is trendless, and therefore may not be an ideal time to enter a trade.

The Difference Between Average Directional Index (ADX) and the Aroon Indicator

The ADX indicator is composed of a total of three lines. The Aroon Indicator is composed of two. The two indicators are similar in that they both have lines representing positive and negative movement, which helps to identify trend direction. The Aroon reading/level also helps determine trend strength, like the ADX does. The calculations are different though, so crossovers on each of the indicators will occur at different times.

Limitations of Using the Average Directional Index (ADX)

Crossovers can occur frequently. Sometimes too frequently, resulting in confusion and potentially lost money on trades that quickly go the other way. These are called false signals. This is more common when ADX values are below 25. That said, sometimes the ADX reaches above 25, but is only there temporarily and then reverses along with the price.

Like any indicator, the ADX should be combined with price analysis and potentially other indicators to help filter signals and control risk.

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