Directional Movement Indicator (DMI) and Average Directional Index (ADX)

Directional Movement Indicator (DMI) and Average Directional Index (ADX) 

Bloomberg Function: Ticker <Equity> <DMI> GO

Created by Welles Wilder (also creator of RSI); DMI measures the “directional movement”, using today’s high and low prices relative to the previous day’s high and low prices.  By smoothing these comparisons over time, DMI uses the theroy that an uptrend sees higher highs, and a downtrend sees lower lows.

BUY signal: Is generated when +DMI (green) crosses up through -DMI (red)

SELL signal: Is generated when +DMI (green) crosses down through -DMI (red)

The ADX is an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. The ADX line is laid over to the DMI to demonstrate the strength of a given trend; where a rising line means the trend is strong and the security is a better candidate for a trend-following system.  When the line has a negative slope, the trend is weakening and a trend following system should generally be avoided.

 

Source: Technical Analysis of the Financial Markets, John Murphy, p. 384-386