What is the Directional Movement Index - DMI
The Directional Movement Index, or DMI, is an indicator developed by J. Welles Wilder that identifies whether a security is trending.
BREAKING DOWN Directional Movement Index - DMI
The Directional Movement Index was developed by J. Welles Wilder in 1978 as a way to help traders avoid false signals. By comparing various moving averages, the indicator helps determine if prices are trending or simply producing noise.
Calculating the Directional Movement Index
The original calculation of the Directional Movement Index involves the following steps:
- Compute the upward price movements (+DI), downward price movements (-DI), and true range of each trading period. If the difference between the current high and the previous high is greater than the difference between the previous low and current low, +DI is the greater of subtracting the current high by the previous high, or zero. If the difference between the previous low and the current low is greater than the difference between the current high and the previous high, -DI is the greater of subtracting the previous low and current low, or zero. If both +DI and -DI are negative, then both are set to zero. If both +DI and -DI are positive, the greater value is used and calculated by either subtracting the current high from the previous high (+DI) or subtracting the current low from the previous low (-DI). True range is the greater of the current low subtracted from the current high, the absolute value of the current high minus the previous close, or the absolute value of the current low minus the previous close.
- Calculate the Welles Wilder's Smoothing Average (WWS) of upwards price movements, downward price movements, and the true range. The formula for this is: WSMA(i) = (SUM1-WSMA1+CLOSE(i))/N, where WSMA1 is the Wilder's Smoothing for the first period, WSMA(i) is the Wilder's Smoothing for the current period (except if it's the first period), CLOSE(i) is the current closing price, and N is the smoothing period.
- Calculate the positive Directional Movement Index (+DI) by dividing the WWS of upwards price movements by the WWS of true range and multiply the result by 100.
- Calculate the negative Directional Movement Index (-DI) by dividing the WWS of downward price movements by the WWS of true range and multiply the result by 100.
- Calculate the aggregate Directional Movement Index (DX) by multiplying the previous ADX values, after the first one, by the specified period minus one, adding the current DX value, and dividing the total by the period specified. The first value is an average of the Directional Index over the specified period of time.
The most common timeframe used for calculating the DMI - e.g. the number of periods to use in the WWS - is 14 periods, although traders may vary this number depending on their needs.
The DMI indicator includes the positive, negative, and aggregate lines. Since these values are normalized, they are plotted as an oscillator that ranges from 0 to 100.
The Average Directional Movement Index, or ADX, is a moving average of the DMI.
Examples of the Directional Movement Index
The chart below shows an example of the Directional Movement Index.
In this chart, the stock exhibits a period where the ADX moves above 60, suggesting a strongly trending market with the +DI exceeding the -DI. Traders may have interpreted this as an opportunity to go long in the stock.
Chart courtesy of StockCharts.com.