DEFINITION of Wilder's DMI (ADX)
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 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.
Example of Wilder's DMI (ADX)
BREAKING DOWN Wilder's DMI (ADX)
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
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. 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. 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 should use trading strategies that exploit range bound 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. (For further reading, see: Technical Analysis: Indicators and Oscillators.)