What it means
Technical analysts study price charts to spot patterns. The DMI helps answer two questions: which way is the market heading, and is the move strong enough to bother trading?
It does this by comparing each day's highs and lows with those of the previous day. The tool has three lines.
The plus directional indicator (+DI) measures upward pressure, the minus directional indicator (-DI) measures downward pressure, and the average directional index (ADX) measures how strong the trend is, regardless of direction. When +DI is above -DI, buyers are generally stronger, and when -DI is higher, sellers dominate.
A common reading is that an ADX value above about 25 suggests a meaningful trend, while a value below about 20 points to a weak or sideways market. These cut-offs are conventions rather than laws, and traders adjust them to suit the market.
Crossovers of +DI and -DI are often watched as possible buy or sell signals. Wilder introduced the idea in the 1970s and typically used a 14-day setting.
Each line is calculated from smoothed averages, so it reacts less sharply than raw prices. The calculation can be done in a spreadsheet, though most charting software supplies it automatically.
Like all technical indicators, the DMI lags behind price because it is built from past data. It can produce false signals in choppy markets and should be used together with other tools, such as volume, support levels or fundamental analysis.
Traders also test any rule on past data before risking money. The index is popular partly because it is simple to apply.
A trader can look at one chart and see direction and strength together, which helps in deciding whether to follow a trend or stay out of the market. It suits markets with clear trends, such as many commodities and currencies, better than those that move sideways.
In practice
Real-world examples.
Example
A currency trader sees the +DI line cross above the -DI line while ADX rises above 25. She takes it as a sign that a new uptrend is forming and opens a small position with a stop-loss. She also checks the weekly chart to make sure the broader trend agrees.
Example
A commodity analyst notices that ADX has been below 15 for weeks. He decides trend-following strategies are unlikely to work and waits for a stronger signal. He saves time by ignoring minor price swings until a trend emerges.
Example
An investor in an index fund checks the DMI before adding to her holding. The -DI is well above +DI and ADX is rising, so she delays buying until selling pressure eases. She keeps her order small, because the indicator can lag when conditions change.
Formula
Calculation
+DI = 100 x (smoothed +DM / average true range)
-DI = 100 x (smoothed -DM / average true range)
DX = 100 x |+DI - -DI| / (+DI + -DI)
ADX = smoothed average of DX over the chosen period
Here +DM and -DM are the upward and downward movements in the price range from one period to the next, and the average true range measures typical daily price movement.
Worked example: Assume the smoothed +DM is 2.0, the smoothed -DM is 1.0 and the average true range is 5.0.
+DI = 100 x (2.0 / 5.0) = 40.
-DI = 100 x (1.0 / 5.0) = 20.
DX = 100 x |40 - 20| / (40 + 20) = 100 x 20 / 60 = 33.3 (rounded).
Because +DI is above -DI, upward movement is stronger. A DX of 33.3 indicates a reasonably strong trend, and ADX smooths DX values over time.
Charting software performs these steps automatically, using smoothing methods that give recent periods more weight. The values you see on a chart may therefore differ slightly from a manual calculation.Case study
Seen in the real world.
Redstone Trading is a fictional small trading desk that used a 14-day DMI on several commodity charts. Early on, the traders bought every time the +DI line crossed above -DI.
In this illustrative case, they lost money repeatedly in a quiet market where the lines crossed back and forth. Reviewing the trades, they noticed that most losses happened when ADX was below 20.
They added a rule to take signals only when ADX was above 25 and tested it on past data before using real money. Their number of trades fell, but results improved. The illustrative lesson is that the strength reading helps filter out weak signals. The desk now records the ADX reading beside every trade in its log so that it can review results by trend strength.
Watch out
Common mistakes.
- Trading every +DI and -DI crossover. In sideways markets the lines cross often and produce many false signals. Wait for ADX to confirm that a trend has real strength before acting on a crossover.
- Treating ADX as a direction indicator. ADX only shows trend strength, so a high reading can occur in a falling market too. The line measures the strength of the trend, so it may rise during a decline.
- Using the DMI on its own. It lags behind price and works best with other evidence. Pair it with volume, support and resistance levels, or other tools.
Questions
People also ask.
What does DMI stand for?
It stands for Directional Movement Index, created by J. Welles Wilder Jr. The calculations use a method published in his 1978 book on technical trading systems.
What setting is normally used?
A 14-period setting is the most common, though traders adjust it for different markets. Shorter periods react faster but produce more false signals, while longer ones are smoother.
Is a high ADX good or bad?
It simply means the trend is strong, which could be an upward or downward trend. A rising ADX means the existing trend, whichever way it points, is strengthening.
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