Directional Movement Index (DMI) points you in the right direction
Created by J Welles Wilder in 1978, the directional movement indicator (DMI) is popularly used to confirm strong and weak trends.
There are three lines in DMI, i.e. the positive (+DMI) that measures how strongly price moves upward, the negative (-DMI) that measures how strongly price moves downward and the key line Average Directional Movement Index (ADX).
- +DMI indicates the strength of the upward price movement
- -DMI indicates the strength of the downward price movement
- ADX indicates the strength of the trend. Whether the price of the instrument is up or down does not affect the ADX. It is only the strength of the trend that matters.
Interpretation of the DMI signals:
DMI Bullish Crossover Buy Signal
When the DMI+ crosses above the DMI-
DMI Bearish Crossover Sell Signal
When the DMI+ crosses below the DMI-
As the DMI crossovers can generate many false signals, ADX strength should be used for confirmation of the DMI crossovers.
Of the two DMI lines, look to see which is more dominant. Usually, a crossover (when the DMI on the bottom crosses up through the dominant DMI on top) takes place to indicate a potential change in direction.
To determine if the new trend is strong, the ADX comes in handy.
The Average Directional Movement Index (ADX) is an important addition to the DMI+ and DMI- indicators. In fact, the ADX is calculated using both DMI lines.
The best trading decisions are made on objective signals and not emotion. By using DMI, you can gauge the strength of price movement.
How to interpret ADX
Below 20: Non-trending market
Cross above 20: Signal that a trend might be emerging
Between 20 & 40: Confirmation of the emerging trend
Above 40: Very strong trend
The ADX is a good complement to other indicators as well. As with all technical indicators, they should never be used in isolation but confirmed with other indicators.