Directional Movement Indicator

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Technical Trading Strategy
Directional Movement Indicator

What is it?
Directional Movement Indicator, or "DMI", is a popular technical indicator used to determine whether or not a currency pair is trending. It was first introduced by Welles Wilder in his book, "New Concepts in Technical Trading Systems".

DMI has three significant lines: the Average Directional Line (ADX), the positive Directional Index (+DI), and the negative Directional Index (-DI). They are plotted all on top of each other, and range from 0 to 100. The mathematical computations for the level of these lines are beyond the scope of this report, but are fully explained in his book. The default time parameter is to use the 14 for both the DMI and ADX period, although the 30-period is occasionally used by highly risk-averse traders.

How can it be used?
A high level of the ADX line indicates that the current trend is strong. If you believe in the saying "the trend is your friend", it should be a part of your trading arsenal. In "Technical Analysis in the Global Currency Markets", a reading under 25 is an indication of a nontrending market (and therefore, range trading strategies should be looked at), while a reading above 40 is an indication of a strong trending market (and therefore, trend trading strategies should be used). Many traders may also use 30 as the significant level for either sides.

+DI measures the bullish movement and the -DI measures the bearish movement in a currency pair. Trading signals are given when the +DI crosses the -DI line. Wilder suggests buying when the +DI rises above the -DI and selling when the +DI falls below the -DI.
You can actually consider the DMI to be a trading system in itself, as you buy or sell on crossovers only when the current trend is strong (and thus you are "following the trend", one of the very basic concepts of technical trading).

It is similar to most oscillators, in that traders may also look for divergence. A divergence occurs when the price makes new highs, but the indicator (in this case, you are looking at the ADX line) does not, and thus indicating a possible reversal of the current trend.
However, many traders will still consider the trend to be strong above the 30-level, even with divergence.

Wilder makes reference to his "extreme point rule" when using the crossover signals. The rule requires that you note the extreme points on the day of the crossover (never enter a trade on the day of the crossover). With a bullish signal, the extreme point is the high of the day, whereas with a bearish signal, it is the low of the day. The rule is to prevent you from whipsaws and "chasing the markets", as you may receive many false signals.


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