Directional Movement Index (DMI) Indicator

Trend indicators

Directional Movement Index (DMI) Indicator
  • The Directional Movement Index (DMI) is composed of 2+1 lines
    • The -DI line shows the selling pressure (-DI),
    • The +DI line shows the buying pressure 
    • And the DX line shows the difference between the two others
  • When +DI is above -DI, it means the price is mainly having an upward movement.
  • When -DI is above +DI, it means the price is mainly having a downward movement.
  • Crossovers can signal emerging trends.
  • The spread between +DI & -DI can show trend strength. The wider, the trendier.

What is the Directional Movement Index?

J. Welles Wilder invented the Directional Movement Index indicator or DMI in 1978. It determines the direction the price of a stock is going. The indicator performs this by comparing prior big and small and drawing two lines: a positive directional movement line (+DI) and a negative directional movement line (-DI), an optional third line, called directional movement (DX). 

The combination of these three indicators namely: Average Directional Index (ADI), Positive Directional Indicator (+DI) and Negative Directional Indicator (-DI) makes up the Directional Movement Index (DMI). The function of ADX is to determine if or not there is a trend present. It does not put direction into consideration.

The two other indicators +DI and –DI are used for complementing ADX. They are useful for knowing trend direction. Again, the combination of these three indicators gives a technical analyst a chance to determine and measure a trend’s strength with its direction.

Uses of Directional Movement Index

One can use DMI in both ranging and trending markets. Basically, the trade market is moving up when the +DI mark is above the –DI mark. The trade market is moving down when the –DI mark is above the +DI mark.

Take long positions when trading a trending strategy if the +DI is higher than the –DI mark, and ensure to stay away from long trades when the –DI is higher than the +DI. 

Go for short positions when the –DI is above the +DI mark and when the +DI is higher than the –DI, stay away from taking short positions.

Formulas for the Directional Movement Index (DMI)

+DI = (Smoothed+DM)*100/ATR

-DI = (Smoothed-DM)*100/ATR

DX = (+DI- -DI)*100/(+DI+ -DI)

Where:

+DM (Directional Movement) = Current High – PH

PH = Previous High

-DM = Previous Low – Current Low

Smoothed +/- DM = t=114DM – (14  t=1  DM / 14 + CDM

CDM = Current DM

ATR = Average True Range

Calculation for the Directional Movement Index

Traders can divide the calculation into two when trading with the Directional Movement. Firstly, calculating the +DI and –DI, and secondly, calculation of the ADX. Look for +DM and –DM (Directional Movement) if you want to calculate the +DI and –DI. +DM and –DM are both calculated with the High, Low and Close per each Period. One can then calculate the following:

UpMove = Current High – Previous High 

DownMove = Previous Low – Current Low

If UpMove > DownMove and UpMove > 0, then +DM = UpMove, else +DM = 0

If DownMove > UpMove and DownMove > 0, then –DM = DownMove, else –DM = 0

As soon as you have calculated the current +DM and –DM, you can then calculate the +DM and –DM lines and plot them on the basis of the figure of user defined periods.

+DI = (+DM / TR) * 100

-DI = (-DM / TR) * 100

ADX = (+DI – – DI) * 100 / +DI + -DI

How Directional Movement works?

The value of DMI is between 0 and 100 and traders use it to determine the strength of the current trend. You can make use of both +DI and –DI to measure direction. A common description would be that during a strong trend (ADX beyond 25 but based on the description of the analyst), a bullish market is defined when the +DI is above the –DI. A bearish market forms when –DI is above +DI.

Something to note is that what DMI values determine, strength or a possible signal, is dependent on trader’s assessment. A technical analyst is able to make reasonable judgment upon the basis of previous examples.

One of the basic uses of the DMI is to decipher trend strength. To decipher trend strength, attention should be on ADX line as opposed to +DI or –DI lines. Crossovers can be used to indicate emerging trends. For instance, the +DI crossing above the –DI may indicate the beginning of an uptrend in price.

Wilder perceived that a DMI reading beyond 25 signifies a strong trend, while a reading beneath 20 signifies a weak or obsolete trend. You can know the right values by looking at previous analysis.

Also, note that Wilder invented the DMI for use with currencies and commodities that usually vary than stocks and have stronger trends. Traders can combine the Average Directional Movement Index (ADX) indicator with the DMI.

Limitations of the Directional Movement Index

Just like with every other indicator, the DMI has its own flaws and imperfections. The Directional Movement Index is from a larger system known as Average Directional Index (ADX). Traders can add the trend direction of DMI with the strength readings of the ADX. Readings beyond the mark of 20 on the ADX is referred to as a strongly trending price. This indicator is still prone to making so many wrong signals whether you use the ADX or not.

+DI and –DI readings and crossovers are dependent on historical prices and do not exactly forecast futuristic happenings and events. A crossover can occur, and price may not respond, leading to lost trade. The lines may as well crisscross, leading to multiple signals but not a single trend in the price. You can sort of avoid this by only taking trades in larger trend direction based on long-term price charts or including ADX reading to assist in isolating strong trends.

DMI has a low sensitivity to the short-term price changes. This limitation is characterized not only to DMI but to also many other types of indicators. It is advisable not to solely use this indicator but it should rather be combined with other technical analysis indicators for optimal trading result.

Difference between the Directional Movement Index and the Aroon Indicator

The DMI indicator is made up of two lines, with an additional third line which is optional. The Aroon indicator also has two lines. These two indicators both show positive and negative movement, which assist traders in determining trend direction. The difference between them exists in their calculation and as a result, crossovers on each of these indicators will appear at different times.

Conclusion

Directional Movement Indicator (DMI) is another form of important technical analysis indicator developed by Welles Wilder. It involves really advanced forms of trend strength and direction, then computes it and displays it in a simple and direct visual form. 

It is difficult to fully understand it, despite the fact that it is capable of providing high end information and great trading signals. A technical analyst needs to continual study re-modifying this indicator so that he/she can fully understand and maximize it. It would go a long way if traders combine the knowledge DMI alongside its functionalities and historical analysis and experience in helping them to have a pleasant and positive trading experience.

Directional Movement is a trend following indicator and is not supposed to be used as the only trading tool. It is just a tool which could be used to keep track of momentum, trend, or direction of market. 

Ideally, both +DI and –DI lines ought to be used among a wider set of indicators in order to ascertain a trend. It is totally up to the trader to decide if he/she will use the indicator for realizing trade signals or just used as an addition to other indicators or means of analysis.

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