The Directional Movement System designed by Welles Wilder is composed of three indicators whose purpose is to help ascertain whether the market is trending and provide traders with signals for trading the trend. The system consists of three lines:
- The Positive Direction Indicator (+DI), summarizes upward trend direction;
- The Negative Direction Indicator (-DI), summarizes downward trend direction;
- The Average Directional Movement Index (ADX), which indicates the degree of trend strength
1. Calculate the current period’s Directional Movement (+DM,-DM)
Today’s High-Yesterdays High =X
Yesterday’s Low-Today’s Low =Y
Three Potentials outcomes are:
|X and Y <0||+DM=0, -DM=0|
|X > Y||+DM=X, -DM=0|
|X < Y||+DM=0, -DM=Y|
2. Calculate the True range (TR), see ATR for calculation of TR
Wilder suggested using 14 periods for the calculations:
+DM14 = Wilders exponential moving average* of +DM14
-DM14 = Wilders exponential moving average* of –DM14
TR14 = Wilders exponential moving average* of TR14
*(See Wilders Moving Average Formula)
3. Calculate the Directional Indicators
-DI14 = -DM14/TR14
Multiply the outputs of +DI14 and -DI14 by 100
4. Calculate the components of the ADX
Calculate the DI Difference; = The Absolute value of the difference between +DI14 and –DI14
Calculate the Directional Index (DX); = DI Difference divided by the sum of +DI14 and –DI14
Calculate ADX; =EMA* of DX
Trading with the Directional Movement System (DMI, ADX)
The DMI (+DI,-DI) and ADX indicators should be used simultaneously to help evaluate whether a currency is in a trending or trading range environment and importantly to identify an impending change in trend.
The ADX helps ascertain whether the currency is experiencing directional movement or not. High readings indicate the currency is experiencing trending trading conditions (has significant directional movement), low readings indicate a lack of directional movement indicative of a trading range market. The ADX tells nothing about the direction the price is moving and should be used only to evaluate its trending or non-trending characteristics.
The DMI (+DI,-DI) should be used to ascertain whether a currency is trending higher or lower. A +DI line above the –DI line indicates an upward trend as +DI (the measure of upward movement) is greater than –DI (the measure of downward movement). A –DI line above the +DI line indicates a downward trend since the measure of downward movement –DI is greater than +DI the measure of upward movement. Convergence of +DI and –DI from extremities can indicate a weakening of the prevailing trend.
Buy alerts are signalled when the +DI lines crosses the –DI line from below and sell signals are given when the –DI crosses the +DI line from below. The strength of the signals provided by the intersections of +DI and –DI can be obtained from the ADX line, this is why the two indicators should be used in unison. Higher readings of the ADX (in general above 25) confirm a firm trend giving confidence to the +DI/-DI crossovers, readings below 20 imply that the trend is weak and that users may wish to ignore the +DI/-DI crossing.
Users may wish to adopt Wilders "rule of points of extremum" to help reduce the potential for false trades. This rule specifies that where +DI crosses the -DI from below a trader will not initiate the buy trade until the upper extreme of the period in question is breached (maximum of candle), and where the –DI crosses the +DI from below traders will not initiate the sell trade until the lower extreme is breached (minimum of candle).