What You Need to Know About Directional Movement Index (DMI)
Directional Movement Index (DMI) is one of the tools that technical traders use in order to check trend trading strategies. It identifies the presence of a definable trend as well as assessing its strength. Technical Indicator DMI was developed by J. Welles Wilder. It is a valuable tool for assessing price direction and strength for trading strategies as it differentiates between strong and weak trends. DMI, directional movement only allows a trader to enter only the strongest trends. Aside from the fact that it can be applied to any underlying vehicle, stocks, mutual funds, exchange-traded funds, futures, commodities and currencies, DMI also works on all time frames. The concept is based on the assumption of upward trend and downward trend: today’s highest price is higher than yesterday’s highest price, and today’s lowest price is lower than yesterday’s lowest price, respectively.
How Directional Movement Index is calculated? DMI is calculated using the price, compares the current price with the previous price range, and displays the result as an upward movement line (+DI), and a downward movement line (-DI), between 0 and 100. In order to reflect the buying and selling pressure in the drawing of a DMI indicator chart, two lines are needed. These two lines are the positive directional indicator, which marked as +DI and measures how strong the price movement in an upward trend is; and the negative directional indicator, which is marked as -DI and measures how strong the price movement in a downward trend is. When checking the DMI lines, it is suggested to look at which of the two lines is higher.
Usually, traders refer line on top as the dominant DMI line and consider it stronger and more likely to forecast the trend direction. In short, the higher the value of the DMI is, the stronger the signal for a trend. On the other hand, the lower this value is, the less the potential for a trending price movement. Furthermore, when the DMI on bottom crosses up through the dominant DMI on top, crossover happens. This crossover is something that is obvious but what traders do when they see the crossover is they confirm the entry or exit signals to increase their chances of making a profitable trade, by using another indicator. Traders consider crossovers unreliable, giving untrue signals when volatility is low and late signals when volatility is high. But they take note crossover as the first indication of a potential change in direction.
How to interpret Directional Movement Index? DMI confirms price action this way: +DMI rises when price rises, and it falls when price falls. On the other hand, -DMI behaves in the opposite manner and moves counter-directional to price, which means that -DMI rises when price falls, and it falls when price rises. Likewise, we can say that price direction is up when the +DMI is dominant and rising. Price direction is down when the -DMI is dominant and rising. However, it is important to consider the strength of the price.