What is Wilder's DMI (ADX) Indicator?
Wilder’s DMI (ADX) consists of three indicators that measure a trend’s strength and direction. Three lines compose the Direction Movement Index (DMI): ADX (black line), DI+ (green line) and DI- (red line). The Average Directional Index (ADX) line shows the strength of the trend. The higher the ADX value, the stronger the trend. The color of the lines can be altered, but black, green, and red are the default in most software.
The Plus Direction Indicator (DI+) and Minus Direction Indicator (DI-) show the current price direction. When the DI+ is above DI-, current price momentum is up. When the DI- is above DI+, current price momentum is down.
- The DMI is a collection of indicators including +DI, -DI, and ADX.
- +DI and -DI measure up and down price movement, and crossovers of these lines can be used as trade signals.
- ADX measures the strength of the trend, either up or down. A reading above 25 indicates a strong trend.
The Formula for Wilder's DMI (ADX) is
How to Calculate Wilder's DMI (ADX)
The indicator has multiple components. Here's how the components are calculated.
- Calculate +DM, -DM, and True Range (TR) for each period. Using 14 periods is common
- Use +DM when Current High - Previous High > Previous Low - Current Low. Use -DM when Previous Low - Current Low > Current High - Previous High.
- TR is the greater of the Current High - Current Low, Current High - Previous Close, or Current Low - Previous Close.
- Smooth the 14-period averages of +DM, -DM, and TR. The TR formula is below. Insert the -DM and +DM values to calculate the smoothed averages of those.
- First 14TR = Sum of first 14 TR readings.
- Next 14TR value = First 14TR - (Prior 14TR / 14) + Current TR
- Divide the smoothed +DM value by the smoothed TR value to get +DI. Multiply by 100.
- Divide the smoothed -DM value by the smoothed TR value to get-DI. Multiply by 100.
- The Directional Movement Index (DX) is +DI minus -DI, divided by the sum of +DI and -DI (all absolute values). Multiply by 100.
- To get the ADX, continue to calculate DX values for at least 14 periods. Then, smooth the results to get ADX
- First ADX = sum 14 periods of DX / 14
- Later values, ADX = ((Prior ADX x 13) + Current DX) /14
What Does Wilder's DMI (ADX) Tell You?
Wilder’s DMI, developed by J. Welles Wilder in 1978, shows the strength of a trend, either up or down. According to Wilder, a trend is present when the ADX is above 25. DMI values range between zero and 100.
If DI+ is above DI-, an ADX reading of 25 or higher indicates a strong uptrend. If DI- is above DI+, an ADX reading of 25 or higher indicates a strong downtrend.
The ADX may stay above 25 even when the trend reverses. Since ADX is non-directional, this shows the reversal is as strong as the prior trend. Traders may find readings other than 25 are better suited to indicate a strong trend in certain markets.
For example, a trader might find that an ADX reading of 20 provides an earlier indication that the price of a security is trending. Conservative traders may want to wait for readings of 30 or above before employing trend following strategies. (To learn more, see: DMI Points the Way to Profits.)
Trading with Wilder’s DMI
There are a number of ways the DMI can be used to trade, in additional to the general guidelines discussed above.
DI Crossovers: Traders could enter a long position when the DI+ line crosses above the DI- line and set a stop-loss order under the current day’s low, or below a recent swing low. When the DI- line crosses above the DI+ line, traders could place a short position with a stop above the high of the current day, or above a recent swing high. Traders could use a trailing stop if the trade moves in their favor to help lock in profits.
Irrespective of whether the trader takes a long or short position, the ADX should be over 25 when the crossover occurs to confirm the trend’s strength. When the ADX is below 20, traders could use trading strategies that exploit range bound or choppier conditions.
DI Contractions and Expansions: The DI+ and DI- line move away from each other when price volatility increases and converge toward each other when volatility decreases. Short-term traders could enter trades when the two lines move apart to take advantage of increasing volatility. Swing traders might accumulate into a position when the lines contact in anticipation of a breakout.
Traders should use Wilder's DMI in conjunction with other technical indicators and price action to increases the probability of making profitable trades.
Example of How to Use Wilder's DMI (ADX) Indicator
The following chart shows Shopify Inc. (SHOP) with both trending periods and less trending periods. -DI and +DI crossover multiple times—potential trade signals—but there is not always a strong trend present (ADX above 25) when those crossovers occur.
If the +DI is already above the -DI, when the ADX moves above 25 (or 20, 30) that could trigger a long trade. These are marked with up arrows.
If the -DI is above the +DI, when the ADX moves above 25 that could trigger a short trade. These are marked with down arrows.
Contraction periods are also marked when the +DI and -DI lines become squished together. These are contractions in volatility, which are often followed by periods of larger, trending movement where the lines separate again. Breakouts from these contractions (blue boxes) may present trading opportunities.
The indicator is susceptible to creating multiple false signals, meaning the price doesn't end up moving in the same direction as the crossover dictates.
Therefore, the indicator is best used in conjunction with other forms of analysis, or with additional filters applied to the signals generated.
The Difference Between Wilder's DMI and Aroon
The two indicators both have crossover signals, but they are calculated in different ways and are measuring different things. DMI is measuring up and down movement by smoothing price fluctuations. The Aroon indicator is measuring the time or periods since a high or low within the look-back period.
Limitations of Using Wilder's DMI (ADX)
The indicator is looking at past data. It may lack predictive value in forecasting future price moves.
The indicator lags and will therefore tend to indicate trend changes after the price has already reversed course. This could lead to some trade signals occurring too late to be of use. This can also occur with the ADX reading. A reading of 20, or 25, or 30 doesn't mean that trend will persist. Many trends will fizzle out after reaching such a reading. The indicator can't predict a trend will continue, only that the security trended recently.
If using the indicator for signals, there will be whipsaws. This is when the indicators criss-cross back and forth, resulting in multiple trade signals which produce losing trades.