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Directional Movement Index: Indicator Offers Simple, Logical Trading Strategy
The Directional Movement Index (DMI) is a required input for the Average Directional Index (ADX) indicator. The Positive Directional Index (+DI) and the Negative Direction Index (-DI) are found separately and then used to calculate ADX, or the two indicators can be used as a standalone trading strategy.
Some websites and trading software will use different terms to describe these indicators. DMI plus is sometimes used for +DI and DMI minus may be used for –DI. The calculation and interpretation is the same no matter what they are called.
Calculating DMI involves many steps and the indicators can easily be found from a variety of sources. In general terms, DMI is positive when the difference between today's high and yesterday's high is greater than the difference between the two lows. It is negative when the difference between the lows exceeds the difference between the highs.
These tools were introduced in J. Welles Wilder's 1978 book, New Concepts in Technical Trading Systems. Wilder was trying to identify whether bulls or bears had more conviction and he used the size of the trading range as evidence of that. He assumed the larger move represented the direction of the trend.
These moves are tracked for the last 14 days and summed together. If DMI is positive for a day, then –DI is equal to zero, and on days when DMI is negative, +DI will be zero. This is definitely a confusing process, but the indicators can easily be found at many websites or in any trading software.
How Traders Use It
The values for DMI are needed to calculate ADX. They can also be charted separately and used as a trading strategy. This is shown in the chart below where the strategy has been applied to silver. Traders would be long when +DI is greater than –DI.
In the chart, +DI is shown as a green line charted below the price and –DI is a red line. Long trades are shown as green boxes.
Three long trades are shown in the chart. One, the second trade, would have generated a loss. The first trade would have lost most of the open profits after the market turned; however, it would have been a winning trade, before considering trading costs. There is no perfect trading system and these types of trades can be seen when using any entry and exit rules.
There are many times when the two indicators rapidly cross each other, and this would lead to a large number of small trades. To avoid that, a trend filter like ADX could be applied to the strategy and signals would then only be taken, for example, when ADX is above 25, which would indicate that a market is trending.
Why It Matters To Traders
DMI offers traders a simple and logical trading strategy, and simple rules-based systems are always appealing. Although the rules are clear and easy to interpret, the system does suffer from the problem of an excessive number of crossover signals at times. However, combined with other trading tools, like ADX or moving averages, DMI can provide valuable input in a trading system.