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The Directional Movement Index (DMI) is a trend-following indicator developed by J. Welles Wilder, Jr., designed to determine whether a security is in a trending or non-trending market. Since the market is in a strong trend only about 30% of the time and in sideways about 70% of the time, this indicator is used to capture the period when the market shows significant trending or directional behavior.

The calculation of the DMI is fairly complex and consists of three lines:

< DMI >
+DI: current positive directional index, the range of highs divided by the price range over the last day and previous close, smoothed over a given number of periods.
-DI: current negative directional index, the range of lows divided by the price range over the last day and previous close, smoothed over a given number of periods.
ADX: modified moving average of the difference of +DI and -DI divided by the sum of +DI and -DI, multiplied by 100.
UpTrend:
.. ADX > 30 the higher the better
.. +DI > -DI
DownTrend:
.. ADX > 30 the higher the better
.. -DI > +DI
8.10 Up

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Directional Movement Index (DMI)

What does it Mean? An indicator developed by J. Welles Wilder for identifying when a definable trend is present in an instrument. That is, the DMI tells whether an instrument is trending or not.

Investopedia Says... The scale for the DMI is from 0 to 100. The average directional movement index (ADX) is a moving average of the DMI.

Discerning Movement with the Average Directional Index - ADX
The Average Directional Index (ADX) measures the strength of a prevailing trend as well as whether movement exists in the market. The ADX is measured on a scale of 0 to 100. A low ADX value (generally less than 20) can indicate a non-trending market with low volumes whereas a cross above 20 may indicate the start of a trend (either up or down). If the ADX is over 40 and begins to fall, it can indicate the slowdown of a current trend. This indicator can also be used to identify non-trending markets, or a deterioration of an ongoing trend. Although market direction is important in its calculation, the ADX is not a directional indicator.

Many technicians who use ADX on a regular basis use a 14-unit ADX (meaning 14 trading days) and end-of-day data (the closing prices of each security being studied). It is important to use the same parameters in each study to reveal consistent findings. Make sure that you never have more than two or three indicators in your studies, allowing for quick decisions to be made when an issue is making a strong move in either direction.

An ADX above 30 on the scale indicates there is a strong trend in that particular time frame. Recall the principle that momentum precedes price. (See Getting Confirmation with the Momentum Strategy.) Therefore, when using ADX in your studies, note that when ADX forms a top and begins to turn down, you should look for a retracement that causes the price to move toward its 20-day exponential moving average (EMA). In an uptrending market, the technician will buy when the price falls to or near the 20-unit EMA, and in a downtrending market, one should look to sell when the price rises to or near its 20 unit EMA.

Investors should know that ADX does not function well as a trigger. Prices will always move faster than the ADX, as there is too much of a smoothing factor, which causes it to lag the price movement.

Interestingly, when ADX drops below 18, it often leads to a sideways or horizontal trading pattern, and the moving averages start to cluster around the price of the security. This signifies basing action within a trading range from which it is possible to draw support and resistance lines. Classic technical analysis tells us the longer the price action moves horizontal, the more likely the chart pattern will be a reversal pattern rather than a continuation pattern. When ADX moves down that low, you are in a breakout mode, and once the price breaks out, you could be setting a new trend. So draw your trendline and look for some type of breakout method.

Each indicator has its weaknesses and the ADX is no exception. Charles LeBeau, a long time trader and writer had this to say in an interview a number of years ago: “Imagine that we have a nice long base. We jump on board when ADX starts rising from a low level. We successfully carry this trade all the way up to a high ADX level, somewhere above 30, and then the market turns down. The ADX will start to decline showing an absence of trending direction, but the price does not have an absence of direction, it is moving down!”
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This entry was posted on Thursday, February 7th, 2008 at 8:23 pm and is filed under Technical Analysis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.