Using the Directional Movement Indicator

The Directional Movement Indicator (or Index) was created by J Welles Wilder in 1978, who also created the popular Relative Strength Index. The DMI is a very useful tool in determining price direction as well as strength. The DMI's primary purpose is to identify the strength of a trend, so that a trend trader can know whether or not the trend is strong enough to invest in. The DMI is composed of two separate lines, the positive directional movement indicator +DMI and the negative directional movement indicator -DMI. The +DMI indicator shows the strength of the upwards price movement while the -DMI shows the strength of the downwards price movement. DMI values under 25 are considered strong directional indicators while values of under 25 are weak directional indicators. The +DMI usually moves with price action, while the -DMI moves inverse to price action.

The location of the two lines is important, as the higher line is considered by some traders to the the "dominant" line and is the line that correlates to price action, when the +DMI is on top then it is more likely to be moving upwards in price and when the -DMI is on top then it is more likely to be moving downwards. A potential trading signal occurs when a crossover of the lines happens, signalling a change in the trend. A crossover occurs when the lower line crosses above the higher line, indicating that a change in trend strength is occurring. These crosses are less than reliable: in times of low volatility there are commonly false signals and in high volatility the signals are usually very late.

Peaks are important to note when looking at this indicator, peaks in +DMI reflect the highs in a bullish rally while peaks in a -DMI represent the lows in a bearish rally. A series of +DMI peaks above the -DMI signal a strong uptrend, while a strong downtrend is characterized by the -DMI peaks above the +DMI. Pivots appear in the DMI when price action changes direction. A +DMI pivot high is caused by price making a pivot high, a -DMI pivot high is caused by price making a pivot low.