How to Trade With the Directional Movement Index (DMI)
Using DMI to Identify Uptrends and Downtrends With Strength
The Directional Movement Index (DMI) is a momentum indicator that was developed by J. Welles Wilder. The DMI is part of a series of technical indicators developed by Wilder, and some trading platforms split up the indicators, providing the Directional Movement as one indicator and the Average Direction Index (ADX) as another. Typically, these indicators are used together to form the DMI. Directional Movement shows whether the downside or upside movement is stronger, and ADX shows the strength of that movement.
Directional Movement Index Basics
The DMI is a technical indicator that is typically shown below or above the price chart and is calculated by comparing the current price with the previous price range. DMI then displays the result as an upward directional index (+DI) and a downward directional index (-DI). The DMI also calculates the strength of the upward or downward movement and displays the result as a trend strength line called Average Directional Index or ADX.
+DI and -DI show up as two separate lines, colored green and red, respectively. When the red line is above the green line, it means the price is dropping. When the green line is above the red line, it means the price is rising. If the -DI and +DI are crisscrossing back and forth, there likely isn't a price trend going on, and the price is moving sideways.
ADX is a third line on the indicator, and it shows the strength of the trend. So while the -DI and +DI help highlight direction, ADX focuses on how strong the uptrend or downtrend is. An ADX reading above 25 signals a strong trend is in place. When the ADX is oscillating below 25, it usually means there isn't a strong trend, and the price is moving sideways or within a weak trend.
The attached chart shows a one-minute chart with ADX and Directional Movement lines. The indicators are separated to avoid clutter, but it is possible (and common) to have the ADX, -DI, and +DI all shown in one window instead of two. The indicators can also be used separately, though. Some traders may only choose to view the ADX for trend strength, while others may prefer only viewing the Direction Movement lines to aid in confirming price direction.
Directional Movement Index Trading Uses
The DMI can be used in both ranging and trending markets. In general, when the +DI line is above the -DI line, the market is moving upwards, and when the -DI line is above the +DI line, the market is moving downwards. When trading a trending strategy, favor long positions when the +DI is above the -DI line, and try to avoid long trades when the -DI is above the +DI. When the -DI is above the +DI, favor short positions, and avoid taking short positions when the +DI is above the -DI.
The market is considered to be trending when the ADX line is above 25, and ranging when the ADX line is below 25. Many traders also consider an ADX reading above 20 as trending, and below 20 as non-trending. Used in conjunction with the Directional Movement uses discussed above, ADX can further filter or confirm trade signals. If trading a trending strategy, the ADX should ideally be above 20 (or 25) for taking trades in potential uptrends or downtrends. For trading strategies that trade ranges (sideways movement), then ADX should be below 20 (or 25).