Technical Studies: Directional Movement Index

The Directional Movement Index, in the words of its inventor, Welles Wilder, "is a system that gives you a definitive entry and exit point in the market and at the same time tells you whether or not you should be trading that particular market."

The DMI is a lower chart study that plots three lines:

• the DMI+ measures the extent to which the security price is trending upwards.
• the DMI- measures the extent to which the security's price is trending downwards.
• the ADX line is an oscillator that is plotted on a 0-to-100 scale. The ADX measures the strength of the security's price trend. A reading above 40 indicates a very strong price trend. A reading below 20 may indicate a very weak trend.

Interpretation: Wilder recommends that traders do the following:

• buy (go long) when the DMI+ crosses above the DMI-
• sell (go short) when the DMI- crosses above the DMI+.
• close positions or take partial profits when the ADX line is above both DMI+ and DMI- lines and turns down.
• stop trading a trend-following system when the ADX line is below both DMI+ and DMI-
• consider trading a trend-following system when the ADX line is above 25. The higher the ADX, the more suitable the security for trading a trend-following system.

The DMI+, DMI- and ADX lines have a customizable default of 14 periods (minutes/hours/days/weeks/months, based on the selected frequency).

Calculating the Directional Movement Index: The formula for Wilder's Directional Movement system is explained in New Concepts in Technical Trading Systems, published in 1978 by Trend Research. ISBN: 0-89459-027-8.