Technical Analysis Indicator - Directional Movement Index (DMI)
Posted by admin on 12/21/07 in Stock Education
Technical analysis indicator - Directional Movement Index (DMI)
DMI was designed by Welles Wilder Jr. who also created the popular relative strength index (RSI).
DMI is made up of three lines :
+DI line
-DI line
ADX line
DMI is a “trending indicator” and often used to check if a trend is present and also the strength of the trend. DMI works on all time frames and can be used for any markets eg. stocks, currencies, options, warrants, exchange traded funds, futures and commodities. +DI line basically moves in the same direction as the underlying securities or stock while -DI line moves in opposite direction.
How to use DI lines :
Buy signal is triggered when there is a crossover ie +DI line moves above -DI line and sell signal when +DI line moves below -DI line. The time periods most commonly used are 10 or 14 days. I prefer to use 10 days since the signal can be triggered sooner and can use it to confirm with other indicators.
One must take note that crossovers of the DMI lines alone are often not very reliable because it may provide false signals when market volatility is low ie range bound and late signals when volatility is high ie trending market.
Divergence signal using +DI line :
Divergence occurs when DMI and stock price disagree with one another.
For example when stock price makes a HIGHER high, but the +DMI makes a LOWER high. This is considered as negative divergence and is generally a warning that upward momentum is losing strength and commonly precedes a retracement or reversal. This should be confirmed with other divergence signals eg by look at moving average convergence divergence (MACD).
How to use ADX line :
A rising ADX line means that the market is trending and as such more suitable to use a trend-following system. A falling ADX line indicates a non-trending or range bound market.
Some traders also look for ADX crossover signals. For example, when ADX line moves above 20 or 25 line, it may be an early signal that market momentum maybe gaining. So if the stock price has been moving up past few days, it could mean more potential upside. But if the stock price has been going down, it could mean more potential downside!!
Also when ADX line goes from above 40 line to below it, that could be an early sign that the trend is weakening.
Some suggested ways to use DMI :
1. A good buy signal is triggered when +DI line is above -DI line AND ADX line is in between the two lines.
2. To avoid whipsaw, do not buy when +DI cross -DI for the first time, wait for a pull back. Buy when price moves up again and break the high of the first day when +DI first crossed -DI.
3. Use higher high of +DI to confirm that uptrend is in tact
article by : RooneyYong ( Email )
victorcpwong | Jan 2, 2008 | Reply
I would like to add some notes to the post.
ADX appraises the quality of trend in a security when it rises above 25 marks. It also confirms the absence
In low volatility phase, ADX declines, +DI and -DI have the tendency to whipsaw and repeat crossing each other up/down. During high volatility, ADX is late in catching the trend. Therefore, this DMI system should be read in conjunction with a second momentum indicator such as RSI (Relative Strength Index), EMA (Exponential Moving Average).
of trend when it is below 25 marks.
ADX, +DI and -DI rarely score above 50 marks. Once they do so, reversal is imminent. Particularly, when ADX rises above both +DI and -DI, the trend is considered over-extended i.e. the trend is too fast too far.
The single best reliable signal from ADX is when ADX rises up from below 15 marks and also below +DI and -DI. This is the first sign of price completing its consolidation phase also known as basing pattern. Break-out from this consolidation is imminent, in the upside or downside. Probability favours the break-out a price reversal more than a continuation of last trend.
The basic weakness in ADX is it is slow. This is because ADX is a double-smoothed indicator. It takes a data window of some 30 periods (days) to plot a 14 periods (days) ADX(14). Hence, the bigger difficulty ADX has is in the handing of V-top and V-bottom.
Considering a bullish scenario +DI > -DI, the typical situation is ADX rising for a while and then price reversal sets in. But ADX continues to rise, because the data window is a 30 periods for a ADX(14). ADX does not reflect this initial price retreat, until the earlier half of rising price data are offset by the later half of falling price data. Only then does ADX top off and reverse. In a volatile V-top formation, this top-out signal is usually too late; resulting in giving up a larger than necessary part of the gain.
The remedies to this defect are two:
(a) Exit the long trade if RSI falls from high overbought level to below 70 marks critical barrier, or
(b) Exit the long trade if -DI crosses above +DI under the rising ADX.
Event (b) does not always happen before the ADX toping off. In a strong trend, the price retreat could be temporary correction or sideway consolidation before further advance.
Nevertheless, Martin Pring recommends that ADX topping off is a good time to take profit on 50% of the trade.
Linda Raschke devised a setup named ‘Holy Grail’. It is basically a pull-back buy/sell:
Again, assuming a bullish scenario where +DI > -DI, ADX > 30 is rising, and price undergoes a correction. (a) In this case, we target price retracement to find support at EMA30.
(b) Enter long upon EMA30 successfully tested (this is a ‘grail’ buy).
(c)Next, as long as ADX remains rising, we target price to return to last high level with probability of exceeding it for exit.
(d) The process could be repeated until ADX reverses to falling mode.
In a trending market where there is impulse, a retracement to the EMA30 is essentially a bullish flag pattern - a pullback in a trend. A ‘grail’ buy/sell is nothing more than an ADX-qualified flag.