The Directional Movement Index (DMI) is something that is fundamental and quite necessary for anyone in the world of trading and investment. It was brought into existence by the ingenuity of J. Welles Wilder Jr. as part of a series of technical indicators whose main function is to predict future price movements by analyzing historical data and statistics to that effect.
DMI is very useful in determining price direction and strength and it is able to accomplish this feat by comparing the current price with a previous price range. DMI finds its best use in determining price trends and analyzing their strengths thus making it a valuable trade strategy. It is split into two; the Directional Index (DI) which analyzes the trend of a commodity or stock and the Average Directional Index (ADX), which assesses the strength of that trend.
On the chart, the directional index displays in two lines of a positive directional index (+DI) and a negative directional index (-DI). Both lines are colored green and red respectively, while the average directional index displays a blue color. When there is a price increase, the +DI rises and when that price falls, so does the +DI. The -DI responds in an opposite manner that is, when price falls, the -DI rises and when it increases, the -DI falls. That way a stock trader is able to monitor the trends, but that is not the end of it. The ADX still has to analyze the trends to determine their strengths for both uptrends and downtrends.
What are Uptrends and Downtrends?
An uptrend occurs when the successive peak and trough of a trendline is higher than the previous one, i.e there are higher highs and higher lows in the price trend, the reverse case thus indicates a downtrend.
How Does ADX determine their strengths?
DMI strength ranges from 0 to 100, with 0 being the lowest point and 100 being the highest. When the peaks of the +DI or -DI are greater than or above 25, it is an indication that the trend is strong but anything below that is not a strong trend but a ranging trend. Some trades however consider price trends above 20 to be strong, but in both cases, the DMI is still very applicable. A strong uptrend shows that the buyers are stronger than the sellers but a strong downtrend is an indication that the sellers are stronger than the buyers.
DMI thus factors for both sellers and buyers on the trade market as it informs the decision making process of both parties and may well be the difference between a good and a bad trader being that the ADX feature, sets up filters that informs the trader's decisions based on the trading strategy that is employed. Any trend trader capitalizes on high and low trends on the market, however it would be erroneous to work solely on price trends alone i.e considering only the directional index as price is constantly fluctuating and more likely to result in a "trading catastrophe" than with the addition of the ADX.