Directional Movement Index (DMI)
Definition:
The Directional Movement Index (DMI) is a trend-following indicator developed by J. Welles Wilder, Jr., designed to determine whether a security is in a trending or non-trending market. Since the market is in a strong trend only about 30% of the time and in sideways about 70% of the time, this indicator is used to capture the period when the market shows significant trending or directional behavior. The calculation of the DMI is fairly complex, and consists of three lines:
- +DI: current positive directional index, the range of highs divided by the price range over the last day and previous close, smoothed over a given number of periods.
- -DI: current negative directional index, the range of lows divided by the price range over the last day and previous close, smoothed over a given number of periods.
- ADX: modified moving average of the difference of +DI and -DI divided by the sum of +DI and -DI, multiplied by 100.
Interpretation:
When the +DI rises above the -DI, it can be considered a signal for an uptrend. When the +DI crosses below the -DI, it can be considered a signal for a downtrend. According to conventional interpretation, three criteria should be met for a signal to be considered valid in most circumstances.
- ADX should be rising
- ADX should be above 50
- Confirmation from another indicator is encouraged pointing towards strong trending or volatility characteristics.
A more strict interpretation of the Directional Moving Index calls for a fourth criterion to be met. For an uptrend to be valid, the price of the security must rise above the high of the day that the +DI crossed above the -DI. For a downtrend to be valid, the price of the security must dip below the low of the day that the +DI crossed under the -DI.
