Directional Movement Index – Video Tutorial

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How to Trade with Directional Movement Index (DMI) – Video Tutorial

Indicator shows buyers & sellers activity and strength and tells if the underlying asset is trending or not. For the most part it is used for trend predictions.

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Directional Movement Index: How it Works?

Directional movement index is displayed with two curves – green showing the strength of the buyers and red showing the strength of the sellers. ADX curve which can be applied onto the DMI indicator is so called average directional movement index and is basically the moving average of DMI indicator. DMI speed is defined with period setting, and the common settings for DMI period are level 14 or 15. If the ADX is above certain level (for example above 40 on 15 period setting) we can expect a trend development. If the ADX is below level 20 for example, we are looking at non-volatile market.

RSI is an oscillator, which means it moves (oscillates) between the levels of 0 and 100. The default period setting for RSI is 14. Most commonly used are periods from 10 to 14, regardless of the time frame. Lower period settings will give more overbought and oversold signals and higher period settings will give less signals, however these are considered to be stronger. RSI levels below 30 are considered as oversold conditions and imply that the price should reverse and move up and levels above 70 are considered as overbought conditions and imply that the price should reverse downwards.

How to use DMI with binary options trading?

DMI and ADX can be used in different ways and is most useful whenever we need to analyze if the market is trending or not, or to predict the occurrence of future trends. DMI can be used as additional indicator with the Algobit Signals Strategy, as explained in the video, or with 5 Minute Trading Strategy as a help to avoid trending markets, for example.

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Average Directional Index – ADX Definition and Uses

What is the Average Directional Index (ADX)?

The average directional index (ADX) is a technical analysis indicator used by some traders to determine the strength of a trend. The trend can be either up or down, and this is shown by two accompanying indicators, the Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI). Therefore, ADX commonly includes three separate lines. These are used to help assess whether a trade should be taken long or short, or if a trade should be taken at all.

Key Takeaways

  • Designed by Welles Wilder for commodity daily charts, but can be used in other markets or other timeframes.
  • The price is moving up when +DI is above -DI, and the price is moving down when -DI is above +DI.
  • Crosses between +DI and -DI are potential trading signals as bears or bulls gain the upper hand.
  • The trend has strength when ADX is above 25. The trend is weak or the price is trendless when ADX is below 20, according to Wilder.
  • Non-trending doesn’t mean the price isn’t moving. It may not be, but the price could also be making a trend change or is too volatile for a clear direction to be present.

The Formulas for the Average Directional Index

(ADX) Indicator are

The ADX requires a sequence of calculations due to the multiple lines in the indicator.

Calculating the Average Directional Movement Index (ADX)

  1. Calculate +DM, -DM, and True Range (TR) for each period. 14 periods are typically used.
  2. +DM = Current High – Previous High.
  3. -DM = Previous Low – Current Low.
  4. Use +DM when Current High – Previous High > Previous Low – Current Low. Use -DM when Previous Low – Current Low > Current High – Previous High.
  5. TR is the greater of the Current High – Current Low, Current High – Previous Close, or Current Low – Previous Close.
  6. 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.
  7. First 14TR = Sum of first 14 TR readings.
  8. Next 14TR value = First 14TR – (Prior 14TR/14) + Current TR
  9. Next, divide the smoothed +DM value by the smoothed TR value to get +DI. Multiply by 100.
  10. Divide the smoothed -DM value by the smoothed TR value to get-DI. Multiply by 100.
  11. The Directional Movement Index (DX) is +DI minus -DI, divided by the sum of +DI and -DI (all absolute values). Multiply by 100.
  12. To get the ADX, continue to calculate DX values for at least 14 periods. Then, smoothe the results to get ADX
  13. First ADX = sum 14 periods of DX / 14
  14. After that, ADX = ((Prior ADX * 13) + Current DX) /14

What Does the Average Directional Index (ADX) Tell You?

The Average Directional Index (ADX) along with the Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI) are momentum indicators. The ADX helps investors determine trend strength while -DI and +DI help determine trend direction.

The ADX identifies a strong trend when the ADX is over 25 and a weak trend when the ADX is below 20.

Crossovers of the -DI and +DI lines can be used to generate trade signals. For example, if the +DI line crosses above the -DI line and the ADX is above 20, or ideally above 25, then that is a potential signal to buy.

If the -DI crosses above the +DI, and ADX is above 20 or 25, then that is an opportunity to enter a potential short trade.

Crosses can also be used to exit current trades. For example, if long, exit when the -DI crosses above the +DI.

When ADX is below 20 the indicator is signaling that the price is trendless, and therefore may not be an ideal time to enter a trade.

The Difference Between Average Directional Index (ADX) and the Aroon Indicator

The ADX indicator is composed of a total of three lines. The Aroon Indicator is composed of two. The two indicators are similar in that they both have lines representing positive and negative movement, which helps to identify trend direction. The Aroon reading/level also helps determine trend strength, like the ADX does. The calculations are different though, so crossovers on each of the indicators will occur at different times.

Limitations of Using the Average Directional Index (ADX)

Crossovers can occur frequently. Sometimes too frequently, resulting in confusion and potentially lost money on trades that quickly go the other way. These are called false signals. This is more common when ADX values are below 25. That said, sometimes the ADX reaches above 25, but is only there temporarily and then reverses along with the price.

Like any indicator, the ADX should be combined with price analysis and potentially other indicators to help filter signals and control risk.

Directional Movement Index

Tutorial about Directional Movement Index (DX) in Technical analysis. How to trade Positive and negative Directional Movement indicators on the stock charts. About Directional Movement Index, its formula and how it is used in technical analysis – the SPY stock chart example.

Technical Analysis and Proprietary Indicators

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Technical Analysis

Technical Analysis, Studies, Indicators:

Directional Movement Index (DX)

Description

The Directional Movement Index (DX) is an intermediate result in calculating of the Average Directional Index (ADX) that was developed by J. Welles Wilder to evaluate the strength of a trend and to define a period of sideway trading. The Directional Movement index is based on the positive and negative Directional indicators and is used to spot crossovers of positive and negative directional indicators – when bullish/bearish change of power takes place.

Technical Analysis, Signals and Trading Systems

In the ADX technical analysis the Positive Directional indicator (+DM) and Negative Directional indicator (-DM) are used to measure the strength of the bullish and bearish trends. One of the way of using Average Directional index is to analyze Positive Directional (+DM) and Negative Directional (-DM) indicators:

  • The Bullish pressure is stronger when Positive Directional (+DM) indicator moves above Negative Directional (-DM) indicator (green line above red line on the chart below). This would be equivalent to the positive readings on the Directional Movement Index (DX).
  • When Positive Directional (+DM) indicator moves below Negative Directional (-DM) indicator (green line below red line on the chart below) we have stronger bearish pressure and this would be equivalent to the negative readings on the Directional Movement Index (DX).
  • Crossovers of the Positive Directional (+DM) and Negative Directional (-DM) indicators (green and red lines on the chart below) could be used in a trading system as BUY/Sell trading signals.
  • Crossovers of the Positive Directional (+DM) and Negative Directional (-DM) indicators are equivalent to the crossovers of the Directional Movement Index (DX) and 0(zero) center line around which it oscillates.

A simple trading system based on the Directional Movement Index (DX) would suggest to buy when DX crosses above zero (turns positive) and sell when DX crosses below zero (turns negative).

Chart 1: SPY stock chart with +DX and -DX indictors and DX index.

Price Momentum Oscillator Formula and Calculations

As was mentioned above the DX ( Directional Movement Index) calculations are based on the Positive Directional indicator (+DM) and Negative Directional indicator (-DM). You may see how +DM and -DM are calculated HERE.

The DX is calculated by using the following formula:

[DX] = ([+DI] – [-DI]) / ([+DI] + [-DI]) * 100

By V. K. for MarketVolume.com

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