Directional Movement Index (DMI)

Overview

The directional movement index (DMI) is a technical indicator created by J. Welles Wider in 1978. Wilder is also the architect of another commonly used indicator called the relative strength index. The DMI is extremely helpful for measuring price direction as well as the strength of the movement. It is generally suitable for trading trending and ranging markets. Many traders use the directional movement index as part of their entry-exit strategy and to make decisions about whether to go long or short.

The DMI is a tool commonly used by traders to distinguish between weak and strong trends. It is extremely popular with individuals who utilize trading strategies based on trend following systems. It can be used to trade a wide variety of assets, including stocks, commodities and currencies. The directional movement index is actually a moving average of the price range and is typically calculated over a 14-day period. The DMI calculation is based on the price range of the asset over a specific period. Then the most recent price is weighed against the previous price range.

A line scaled from 0 to 100% is used for the purpose of rating the directional movement of a price. The higher the value of the DMI is, the stronger the signal for a trend. On the other hand, the lower this value is, the less the potential for a trending price movement.

Two lines are needed that reflect the buying and selling pressure in the drawing of a DMI indicator chart. The positive directional indicator, marked as DMI+, measures how strong the price movement in an upward trend is, whereas the negative directional indicator is marked as DMI- and measures how strong the price movement in a downward trend is.


Image and video hosting by TinyPic


The first thing to look for when examining the DMI lines is which of the two is higher. Some trend traders refer to line on top as the dominant DMI line and consider it stronger and more likely to forecast the trend direction. It is regarded that bullish market conditions are experienced when the -DI is lower than the +DI. The vice versa is true for bearish market conditions.

Trading Signals

A number of different trading systems have developed around Directional Movement. The following rules are based on the system presented by Dr Alexander Elder in Trading for a Living:

Go long when DMI+ (+DI) is above DMI- (-DI) and either:

  • ADX rises while +DI and ADX are above -DI; or
  • ADX turns up from below +DI and -DI.
Exit when +DI crosses below -DI.

See ADX for further details.

Go short when -DI is above +DI and either:

  • ADX rises while -DI and ADX are above +DI; or
  • ADX turns up from below +DI and -DI.
Exit when -DI crosses below +DI.

Use stop-losses at all times.

Additional Notes

  1. The DMI crossovers can generate many false signals, so the other indicators should be used for confirmation of the DMI crossovers.
  2. The Average Directional Movement Index (ADX) is an important addition to the DMI+ and DMI- indicators. In fact, the ADX is calculated using both DMI lines.

Sources and Additional Information:




Related Posts Plugin for WordPress, Blogger...

3-column blogger templates(available in 4 different styles)