Directional Movement Index – Video Tutorial

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How to Trade with Directional Movement Index (DMI) – Video Tutorial

Indicator shows buyers & sellers activity and strength and tells if the underlying asset is trending or not. For the most part it is used for trend predictions.

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Directional Movement Index: How it Works?

Directional movement index is displayed with two curves – green showing the strength of the buyers and red showing the strength of the sellers. ADX curve which can be applied onto the DMI indicator is so called average directional movement index and is basically the moving average of DMI indicator. DMI speed is defined with period setting, and the common settings for DMI period are level 14 or 15. If the ADX is above certain level (for example above 40 on 15 period setting) we can expect a trend development. If the ADX is below level 20 for example, we are looking at non-volatile market.

RSI is an oscillator, which means it moves (oscillates) between the levels of 0 and 100. The default period setting for RSI is 14. Most commonly used are periods from 10 to 14, regardless of the time frame. Lower period settings will give more overbought and oversold signals and higher period settings will give less signals, however these are considered to be stronger. RSI levels below 30 are considered as oversold conditions and imply that the price should reverse and move up and levels above 70 are considered as overbought conditions and imply that the price should reverse downwards.

How to use DMI with binary options trading?

DMI and ADX can be used in different ways and is most useful whenever we need to analyze if the market is trending or not, or to predict the occurrence of future trends. DMI can be used as additional indicator with the Algobit Signals Strategy, as explained in the video, or with 5 Minute Trading Strategy as a help to avoid trending markets, for example.

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Directional Movement Index – DMI Definition and Uses

What Is the Directional Movement Index (DMI)?

The Directional Movement Index, or DMI, is an indicator developed by J. Welles Wilder in 1978 that identifies in which direction the price of an asset is moving. The indicator does this by comparing prior highs and lows 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) shows the difference between the lines. When +DI is above -DI, there is more upward pressure than downward pressure in the price. If -DI is above +DI, then there is more downward pressure in the price. This indicator may help traders assess the trend direction. Crossovers between the lines are also sometimes used as trade signals to buy or sell.

Key Takeaways

  • The Directional Movement Index (DMI) is composed of two lines, and an optional one, showing selling pressure (-DI), showing buying pressure (+DI), and a third DX line showing the difference between the former positive and negative lines.
  • A +DI line above the -DI line means there is more upward movement than downward movement.
  • A -DI line above the +DI line means there is more downward movement than upward movement.
  • Crossovers can be used to signal emerging trends. For example, the +DI crossing above the -DI may signal the start of an uptrend in price.
  • The larger the spread between the two lines, the stronger the price trend. If +DI is way above -DI the price trend is strongly up. If -DI is way above +DI then the price trend is strongly down.
  • The Average Directional Movement Index (ADX) is another indicator that can be added to the DMI.

The Formulas For the Directional Movement Index (DMI) Are:

Calculating the Directional Movement Index (DMI)

  1. Calculate +DM, -DM, and True Range (TR) for each period. Typically 14 periods are used.
  2. +DM is the Current High – Previous High.
  3. -DM is the Previous Low – Current Low.
  4. Use +DM when Current High – Previous High is greater than Previous Low – Current Low. Use -DM when Previous Low – Current Low is greater than Current High – Previous High.
  5. TR is the greater of the Current High – Current Low, Current High – Previous Close, or Current Low – Previous Close.
  6. Smooth the 14-period averages of +DM, -DM, and TR. Below is the formula for TR. Insert the -DM and +DM values to calculate the smoothed averages of those as well.
  7. First 14TR = Sum of first 14 TR readings.
  8. Next 14TR value = First 14TR – (Prior 14TR/14) + Current TR
  9. Next, divide the smoothed +DM value by the smoothed TR value to get +DI. Multiply by 100.
  10. Divide the smoothed -DM value by the smoothed TR value to get-DI. Multiply by 100.
  11. The optional Directional Movement Index (DX) is +DI minus -DI, divided by the sum of +DI and -DI (all absolute values). Multiply by 100.

The Average Directional Movement Index, or ADX, is a smoothed average of DX.

What Does the Directional Movement Index (DMI) Tell You

The DMI is primarily used to help asses trend direction and provide trade signals.

Crossovers are the main trade signals. A long trade is taken when the +DI crosses above -DI and uptrend could be underway. A sell signal occurs when the -DI drops below -DI. A short trade is initiated when -DI drops below +DI because a downtrend could be underway.

While this method may produce some good signals, it will also produce some bad ones since a trend may not necessarily develop after entry.

The indicator can also be used as a trend or trade confirmation tool. If the +DI is well above -DI, the trend has strength to the upside and this would help confirm current long trades or new long trade signals based on other entry methods. If -DI is well above +DI this confirms the strong downtrend or short positions.

The Difference Between the Directional Movement Index (DMI) and the Aroon Indicator

The DMI indicator is composed of two lines, with an optional third line. The Aroon Indicator also has two lines. The two indicators both show positive and negative movement, helping to identify trend direction. The calculations are different though, so crossovers on each of the indicators will occur at different times.

Limitations of the Directional Movement Index (DMI)

The directional movement index (DMI) is part of a larger system called the Average Directional Movement Index (ADX). The trend direction of DMI can be incorporated with the strength readings of the ADX. Readings above 20 on the ADX means the price is trending strongly. Whether using ADX or not, the indicator is still prone to producing lots of false signals.

+DI and -DI readings and crossovers are based on historical prices and don’t necessarily reflect what will happen in the future. A crossover can occur, but the price may not respond, resulting in a losing trade. The lines may also crisscross, resulting in multiple signals but no trend in the price. This can be somewhat avoided by only taking trades in the larger trend direction based on long-term price charts, or incorporating ADX readings to help isolate strong trends.

Directional Movement Index – Video Tutorial

The Directional Movement Index (DX) was developed by J. Welles Wilder to evaluate the strength of a trend and define periods of sideway trading. The Directional Movement Index is a raw version of the ADX (Average Directional Index), which is calculated as an exponential moving average from DX. The Directional Movement Index can be used in technical analysis in the same way as ADX to determine whether the market is trending or trading (moving sideways).

Technical Analysis

In most cases, the Directional Movement Index appears in charts as ADX (Average Directional Movement Index) combined with positive and negative directional indexes. In addition to being able to use DX or ADX to define the strength of a trend, you can use positive and negative directional indexes to generate signals. In its most basic form, buy and sell signals can be generated by +DI and -DI crossovers. In technical analysis, a buy signal is considered to occur when +DI moves above -DI and a sell signal when -DI moves above the +DI. However, traders should be aware that, when an analyzed security is in a trading range (ADX or DX is below 20), the trading system may produce many false signals and whipsaws.

As with most technical indicators, +DI and -DI crosses should be used in conjunction with other aspects of technical analysis. Since Directional Index is based on the price, we recommend that a volume-based technical analysis be used as a partner to this indicator in a trading system.

Chart 1: S&P 500 – Directional Movement Index as
ADX (Average Directional Movement Index) combined with
positive and negative directional indexes

Formula and Calculations

Directional Movement Index calculations are based on the positive Directional Index (+DI) and negative Directional Index (-DI). You can see an example of the detailed calculation in the ADX description. The Directional Movement Index is a ratio of the absolute value of the difference between directional indexes and the sum of directional indexes. It is calculated by use of the following formula:

[DX] = (|[+DI] – [-DI]|) / ([+DI] + [-DI]) * 100

By V. K. for MarketVolume.com

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