Here’s how you can use the Directional Movement Index to analyze trading opportunities.
What Is the Directional Movement Index?
The DMI is a technical indicator that is typically shown below or above the price chart. It is calculated by comparing the current price with the previous price range. DMI then displays the result as an upward, positive directional indicator (+DI or +DMI) and a downward, negative directional indicator (-DI or -DMI). The DMI also calculates the strength of the upward or downward movement and displays the result as a trend strength line called Average Directional Index or ADX.
Directional Indicators (+DI and -DI)
+DI and -DI show up as two separate lines, typically colored green and red, respectively. +DI is the difference between the highest price of the current day and the highest price of the day before, and -DI does the same calculation with the current and previous day’s lows. When the red line is above the green line, it means the price is dropping. When the green line is above the red line, it means the price is rising. If the -DI and +DI are crisscrossing back and forth, there likely isn’t a price trend going on, and the price is moving sideways.
Average Directional Index (ADX)
ADX is a third line on the DMI, and it shows the strength of the trend. So, while the -DI and +DI help highlight direction, investors use ADX to gauge how strong that uptrend or downtrend is. An ADX reading above 25 signals that a strong trend is in place. When the ADX dips below 20, there isn’t a trend, and the price is likely moving sideways.
Directional Movement Index Trading Uses
The DMI can be used in both ranging and trending markets.
Using the DMI to Trade Trends
In general, when the +DI line is above the -DI line, the market is moving in an uptrend, and when the -DI line is above the +DI line, the market is moving in a downtrend. Therefore, when trading a trending strategy, favor long positions when the +DI is above the -DI line. When the -DI is above the +DI, favor short positions. These indicators can be used in conjunction with the ADX to further filter or confirm trade signals.
Using the DMI to Trade Ranges
Other traders prefer to scout out trades that depend on choppy price action. When trading is range-bound and choppy, that means the ADX is likely below 20. This can present different opportunities, such as an iron condor options spread, in which the trader profits from sideways movement. While these kinds of strategies benefit from ranges, many traders still take a slightly bullish or bearish position on the price, and the directional indicators can be used to establish those positions.
