- ADX
Directional movement Index main page -
ADX Directional
Movement Index
DMI indicates
when a trend is present and the overall strength of
a market.
Overview
- The higher
the DMI (on a scale of 0-100) the better the trend
potential of a move.
- The DMI system
is made up of three lines; ADX and +DI & -DI.
- DMI can be
used either as a system on its own or as a filter
for a trend-following indicator (i.e., Parabolic
SAR).
The
Directional Movement Index, DMI, is an effective and
frequently used trend indicator. This system was designed
by Welles Wilder Jr. and is made up of three lines:
- The +DI indicates
the up average.
- The -DI indicates
the down average.
- The ADX, average
directional movement index, shows whether a trend
is in effect by smoothing the difference between
the +DI and -DI.
In the example
above two clear buy signals have been generated. The
first could have been ignored because ADX was very
close to 25 - a potential danger signal. The second
was perhaps more significant, even though ADX was
trending downwards. It did provide a clear indication
of the beginning of a very strong move in this market.
Buy and sell
signals are given when +DI and -DI cross. The time
periods most commonly used in the complex formula
are 10 or 14 days.
According
to Wilder the DMI should be used with the ADX as a
filter.
- A rising ADX
line means the market is trending and a better
candidate for a trend-following system.
- A falling ADX
line indicates a non-trending market.
- Some traders also
look for an ADX greater than 20 or 25 to confirm
that the market is trending. When the ADX line
starts to drop from above the 40 level,
that is an early sign that the trend is weakening.
A rise back above 20 is often a sign of
the start of a new trend.
Generally
speaking, the two main buy and sell signals generated
by DMI are as follows:
- A buy signal
is given when +DI crosses above the -DI line.
- A sell signal
is given when +DI crosses below the -DI line.
However, some
refinements are suggested by experienced traders:
- The crossing of DI
lines only provides an early warning signal; other
criteria must be fulfilled for the actual signal.
- The ADX should be
between the upper DI line and the lower one.
- An ADX below 25 is
a strong warning to avoid trading.
Wilder himself
developed a refinement to take care of whipsawing
(when the DI lines cross back and forth over a short
period, providing unreliable signals). He called it
his Extreme Point Rule.
The Extreme
Point Rule is derived by noting the high or low
point on the day when the +DI and the -DI cross one
another. +DI determines the high or low point (if
+DI is above -DI the Extreme Point is the high
of the day, if +DI is below -DI, the Extreme
Point is the low for the day).
The extreme
point is then used for the actual buy or sell signal.
For example, if the price once again rises above the
Extreme Point price level you have a buy signal. If
the price fails to rise above the extreme point, you
should continue to stand aside. The converse holds
true for sell signals.
An additional
indicator, the average directional movement index
rating (ADXR), was created by Wilder as a measuring
tool for the strength of ADX. ADXR is the average
of the current ADX and the ADX 14 days ago. ADXR is
typically plotted alongside ADX on the same chart.
Also see the
Parabolic SAR indicator. |
