Average Directional Movement Index (DMI - ADX)
Let's put some questions before proceeding into the topic.
- What is DMI (Directional Movement Index)?
- What is ADX (Average Directional Index)?
- What is the difference between DMI and ADX?
Many traders may have a wrong assumption that both DMI and ADX are same. Not exactly, but ADX is used in coordination and conjunction with other indicators (DI) to complete DMI.
Directional Movement Index (DMI) is an indicator consists of Positive Directional Indicator (+DI), Negative Directional Indicator (-DI) and Average Directional Index (ADX). ADX oscillator is derived from +DI and –DI.
In short and in real, DMI is an indicator which has directional indicators (+DI and –DI) with ADX oscillator or without ADX oscillator. As Welles Wilder, developer of DMI/ADX finds that the combination of these three delivers great results, he prescribed the same.
ADX is an oscillator which indicates the strength of the market. To some extent, it serves the purpose of volatility indicator. We would like to stress on a point that ADX does NOT tell us the direction of the market, whether bull or bear. It only indicates the strength of the market. As we said before, many traders have a wrong view on ADX. Let us clear that initially before going deep into the study.
Average Directional Index (ADX) Oscillator
ADX has a value from 0 to 100. If the reading is below 20 it means that trend of the market is weak and remains sideways (literally tells only about volatility). If the reading is above 40, a strong trend is the indication. In detail, if the line move from below 20 towards 40, markets are likely to enter into a trending zone. If it moves from 40 to 20, the volatility may end and market tries to consolidate.
Note that if the oscillator is around 20, it doesn’t mean that the markets are bearish and if the indicator is around 80, it is not a bullish market. It only delivers the strength of the trend. For instance, a strong falling market may also give a reading of 60+ as the trend is very strong. As well, a strong bull market may also give the same reading of 60+. So, it doesn’t really matter whether the market is of bullish or bearish. And finally, if the markets are not in a good movement, it would give a reading around 20 or 30.
Directional Indicators (DI)
As said above, there are two DIs – Positive and Negative. +DI measures the force of up moves whereas –DI measures the force of down moves. The crossovers of +DI and –DI gives us the buy and sell signals. If +DI is over (crosses) –DI, a buy signal is formed and if –DI is over (crosses) +DI, it is said be a sell signal. General setting of this would be 14 periods. These signals are used when ADX readings are good enough above 40 which indicate that the DMI signals are true and trend is strong. Oscillators are recommended to use in conjunction with other indicators, not relying on just one oscillator.