Traders Toolbox: How to use the Directional Movement Index

Posted on by The INO.com Team

The Directional Movement Index, commonly called the DMI, is a powerful trend-following indicator. Many false signals generated by indicators such as the stochastics are filtered out by the DMI. Subsequently, this trading and analytical tool gives few signals, but, when generated, they tend to be very reliable.

Many, who at first glance are strangers to the DMI, find they are familiar with the prime component of the index: The ADX or average directional movement index. This discussion will center on the main use of the ADX, the turning point concept.

The DMI consists of three components: The + DI, which represents upward directional movement; the - DI, indicating downward movement; and the ADX, which signifies the average directional movement within a market.

In STRONG UPTRENDING moves, such as the late 1989 and early 1990 rally in the CRB, the + DI and the ADX turn up early in the move and move higher, with the + DI generally holding above the ADX. A high probability signal the uptrend has stalled or ended is generated when the ADX crosses above the +DI and turns down. This signal commonly occurs on the trading period of the trend change or slightly before. It rarely takes more than a few periods past a true trend shift to see the ADX turn down.

The rules for signalling a potential bottom are the same as for a top: Simply substitute the - DI for the + DI. There appears to be one slight difference between tops and bottoms: Generally, the ADX turns from a higher level when marking a top.

Several chart services plot only the ADX. In these instances, it can generally be assumed that a downturn in the ADX which occurs after crossing above 40 will have seen the ADX cross above the + DI if the market had been in an uptrend and above the -DI if in a downtrend. In simple terms, a move by the ADX above 40 followed by a downturn generally signals a probable trend change.

Signals such as those which occurred in May, 1990 and February, 1991 in the CRB index (arrows) can be very valuable in confirming a turn which had been projected by unrelated methods of technical analysis. ADX signals can help confirm the expected completion of a wave structure or to underscore a turn within a critical time period.

The DMI is based on a certain number of periods. I have had the most success with 14 days on daily charts. And with the exception of Treasury Bonds, for which I use 14 weeks, I prefer to use 9 periods on the weekly and monthly charts.

Editors note: While the examples shown are somewhat dated the concept and use of the ADX is not. The ADX indicator is available on MarketClub.

14 thoughts on “Traders Toolbox: How to use the Directional Movement Index”

  1. I have used DMI for several months now in conjunction with OBV (On Balance Volume), 2-Line MACD and Momentum (28). Also, the 200, 100, 50 SMAs and the 15 EMA makes a pretty loaded toolbox, but packed with the
    right stuff. My win/loss ratio has improved dramatically.

  2. Dear Lindsay.

    Could you please implement a "normal" messageboard on Marketclub.
    I think it would be much easier for many members including me 😉
    Thanks......

    1. Marco,

      We have talked about doing this, however we have a few more improvements to make before we can confirm the addition of a chat function.

      Thanks though for the suggestion. I will make sure we keep a running dialog in the office about a chat function.

      Best,

      Lindsay Thompson
      Director of New Business Development
      INO.com & MarketClub

    1. Robert,

      Since the DMX is representatives of 3 components, you can find the ADX, +DI, and -DI all under the "Average Directional Index" study as you can see below.

      Best,

      Lindsay Thompson
      Director of New Business Development
      INO.com & MarketClub

  5. Hi everyone once again.

    Adam, where can I find this DMI/ADX tool?. I can't seem to find it in my "under the chart tools".

    Also, Everytime I post a question in this blog, I can never seem to find the blog again to check for an answer. Can anybody please tell me how I can come directly back to this page and check my answers? since I only seem to get here once in a while by "sheer luck".

    Thanks Adam, and everyone.

    Hugo.

    1. Hi Hugo,

      The ADX tool can be found in the "Below Chart" pulldown. I have inserted an image below with the ADX highlighted to make it easier for you to find.

      Also, if you want to make sure you receive answers to your blog questions, please check the "Subscribe to comments via email" and you'll see any other comment for the post as well as the replies from Adam or others.

      *What every you do, make sure you do not click subscribe to comments via email for any contest posts or you will be bombarded. If you happen to do this, or you decide you no longer with to receive emails for this post, you can always chose "Remove me from this list" at the bottom of all the comment emails.

      Best,

      Lindsay Thompson
      Director of New Business Development
      INO.com & MarketClub

  6. Trend Master Series, also by Dr. Schaap teaches everything you need to know about setting stops. In a trend or swing trade, he gives specific rules, I have found it invaluable.

  7. Please just teach me how to set stops wide enough to make the most of a trend. I know through the triangles what the probable trend is, however because the market moves in jagged edges even knowing the trend doesn't help if stops are garbage.

    What's frustrating is that you know the direction of the train and that you want to be on it but you just keep missing it and losing money. Makes you feel so dumb giving money away yet you're doing the right thing.

    Some course say go with tight stops and others set them real wide - somehow I'm missing the point, if the triangles are a reliable system that has a high probability of success then doesn't it make sense to have faith in your system and set wide stops.

    That is - stops outside the trend line of the signal chart. I guess that would be the weekly chart if the trend is determined by the weekly.

    Cheers

    1. Hi Geoff.

      I can relate to your frustration for sure. What I have learned over the years is that I place my stop on the previous swing High/Low on the time frame that is giving the signal.

      In order to keep my money management in check I set the trade amount to match the potential draw-down to not exceed 2% of my account if the stop is hit.

      Cheers

  8. almost every experience trader suggest ADX as a confirmation indicator when i read their blog.

    i'm myself using ADX as a confirmation signal to other indicator signal especially during the initial Swing trade. So far so good.

    Combine it with convergence/divergence method, its almost perfect indicator. The problemm is do we really understand what ADX telling us....

  9. Thank You For a Very Good Post.
    Bear in mind that increasing the number of periods will smooth the ADX line (making it less volatile), and display more significant readings. The readings, however, will present more of a lag. For example, if charting 30 periods, readings over 40 become stronger indicators of a trend. However, the trend may have already started and could have been caught earlier less periods were used.

  10. The most extensive discussion on the ADX (ADXcellence - Power Trend Strategies) is a book by Charles Schaap. He uses 13/8 by the way. The book is very expensive, but it does handle the topic in 272 pages.
    If the trend is really in place, the ADX and its components +DI and -DI give a heads up. Like everything else in investing, nothing is perfect and stop loss is the mantra.

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