Directional Movement Index (DMI)

Directional movement is a system for providing trading signals to be used for price breaks from a trading range. The system involves 5 indicators which are the Directional Movement Index (DX), the plus Directional Indicator (+DI), the minus Directional Indicator (-DI), the average Directional Movement (ADX) and the Directional movement rating (ADXR). The system was developed J. Welles Wilder and is explained thoroughly in his book, New Concepts in Technical Trading Systems.

The basic Directional Movement trading system involves comparing the 14-day +DI and the 14-day -DI. This can be done by plotting the two indicators on top of each other or by subtracting the +DI from the -DI. Wilder suggests buying when the +DI rises above the -DI and selling when the +DI falls below the -DI. Wilder qualifies these simple trading rules with the “extreme point rule.” This rule is designed to prevent whipsaws and reduce the number of trades. The extreme point rule requires that on the day that the +DI and -DI cross, you note the “extreme point.”

Such that:

1. If prices rise for 14 continuous days. Then +DI will be a large percentage and –DI will be a smaller percentage. Thus, the difference between +DI and –DI is large and it is a very directional market.
2. If prices fall for 14 continuous days. Then -DI will be a large percentage and +DI will be a smaller percentage. Thus, the difference between -DI and +DI is large and it is a very directional market.
3. If price fluctuate making little progress then +DI and –DI will be close and difference between them would be small.

Points to Remember

The +DI line will always rise in a clear up trend

The –DI Line will always rise in a clear down trend

The ADX line will be smoother than the other two. It will rise as the +DI and –DI lines are separating.

Directional Movement System

The System:

1. Attempts to deal with the problem of identifying market rending patterns to enhance trend following approaches.
2. Is usually used as a stand alone trend following trading system
3. Is used as a signal for when to employ other trend following indicators. You would use them only when the Directional Movement system indicates that a trend is present. When a trend is not present, you remain out of the market or use momentum oscillators.

Up Trending Day: +DM is that part of today’s range that is above yesterdays high

Down Trend Day: -DM is that part of today’s range that is below yesterdays low

Inside Day: ZERO DM

Outside Day: +DM or –DM depending upon which ‘outside’ range is greater. If both are same then ZERO

Upward gap: +DM is the range from yesterdays high to today’s high

Downward gap: -DM is the range from yesterdays low to today’s low

Concept of True Range

True range is the defined as the greatest of:

1. The high today less the low today
2. The high today less the close tomorrow
3. The close yesterday less the low today

True range is always ALWAYS A POSITIVE NUMBER.

Directional Indicator

The DI for one day will be either positive or negative:

• -DI DOES NOT MEAN a negative number but rather just describes the direction of movement.
• Cannot have a +DM and –DM for the same day.
• As DM on an inside day is zero then DI on an inside day will also be zero

Average directional movement index

True directional movement is the difference between +DI and –DI.

The greater the difference between +DI and –DI, the more directional the movement of the instrument being analysed.

Trading Rules – stand alone system

• Go Long when + DI crosses from below to above –DI
• Go short when –DI crosses from below to above +DI

Additional Rules

• Only take these signals when the ADX turns up from below both DI lines.
  • Extreme point on the day the DI lines cross should be used as a stop loss level even if the DI lines cross against your position for several days. Extreme point if the +DI rises above the –DI is the low of the day of the crossing.
  • Extreme point if –DI rises above +DI is the high of the day of the crossing. The logic here is to cut out the frequent whipsaws experienced around DI line crossovers.
• Take profits if ADX turns down. This is based on the fact that ADX turns down above both DI Lines near the end of trends.
• Trade if ADX is above 25 or falls below 20.

Normal Formula:

Too Complex

Typical Charting Program Formula:

TR := SUM(MAX(MAX(HIGH-LOW,ABS(HIGH-REF(CLOSE,1))),ABS(LOW-REF(CLOSE,1))),N);

HD := HIGH-REF(HIGH,1);

LD := REF(LOW,1)-LOW;

DMP:= SUM(IF(HD>0 & HD>LD,HD,0),N);

DMM:= SUM(IF(LD>0 & LD>HD,LD,0),N);

PDI: DMP*100/TR;

MDI: DMM*100/TR;

ADX: MA(ABS(MDI-PDI)/(MDI+PDI)*100,M);

ADXR:(ADX+REF(ADX,M))/2

Formula Parameters:

Directional Movement Indicator Chart: