The ADX and the DMI are two technical indicators that are often used together to measure the strength and direction of a trend. They were developed by J. Welles Wilder in 1978 and are part of his Directional Movement System. 1 \uFEFF In this article, we will explain what these indicators are, how they are calculated, and how they can be used in trading.
What Is the ADX Indicator?
The ADX stands for Average Directional Index. It is an indicator that measures the strength of a trend, regardless of its direction. The ADX ranges from 0 to 100, with higher values indicating stronger trends and lower values indicating weaker or non-trending markets.
The ADX is derived from two other indicators, called the Plus Directional Indicator (+DI) and the Minus Directional Indicator (-DI). These indicators measure the positive and negative price movement, respectively, and are used to determine the direction of the trend.
The ADX is calculated as follows
• Calculate the +DI, -DI, and True Range (TR) for each period. The TR is the greatest of the current high minus the current low, the current high minus the previous close, or the current low minus the previous close.
• Smooth the 14-period averages of +DI, -DI and TR using Wilder’s smoothing technique. The formula for smoothing TR is:
First 14TR = Sum of first 14 TR readings.
Next 14TR value = First 14TR – (Prior 14TR / 14) + Current TR
• Divide the smoothed +DI value by the smoothed TR value to get +DI. Multiply by 100.
• Divide the smoothed -DI value by the smoothed TR value to get -DI. Multiply by 100.
• Calculate the Directional Movement Index (DX) as:
DX = (+DI – -DI) / (+DI + -DI)
Multiply by 100 and take the absolute value.
• Smooth the DX values using Wilder’s smoothing technique to get ADX. The formula for smoothing DX is:
First ADX = sum of first 14 DX values / 14
Next ADX value = ((Prior ADX x 13) + Current DX) / 14
What Is the DMI Indicator?
The DMI stands for Directional Movement Index. It is not a single indicator, but a collection of three indicators: +DI, -DI, and ADX. The +DI and -DI show the direction of the trend, while the ADX shows its strength.
The DMI can be used to identify whether the market is trending or ranging and whether the trend is bullish or bearish. The general rules for using DMI are:
• When ADX is above 25, it indicates a strong trend. When ADX is below 25, it indicates a weak or non-trending market.
• When +DI is above -DI, it indicates an uptrend. When -DI is above +DI, it indicates a downtrend.
• When +DI crosses above -DI, it signals a bullish trend reversal. When -DI crosses above +DI, it signals a bearish trend reversal.
• When ADX rises above both +DI and -DI, it indicates a very strong trend.
How to Use ADX and DMI in Trading
ADX and DMI can be used in various ways to enhance trading decisions. Here are some examples:
• Trend-following strategies: Traders can use ADX and DMI to identify strong trends and trade in their direction. For example, traders can enter long positions when +DI is above -DI and ADX is above 25, and exit when either condition changes. Conversely, traders can enter short positions when -DI is above +DI and ADX is above 25, and exit when either condition changes.
• Trend-reversal strategies: Traders can use ADX and DMI to identify potential trend reversals and trade against them. For example, traders can enter short positions when +DI crosses below -DI and ADX is above 25, and exit when either condition changes. Conversely, traders can enter long positions when -DI crosses below +DI and ADX is above 25, and exit when either condition changes.
• Range-bound strategies: Traders can use ADX and DMI to identify range-bound markets and trade within them. For example, traders can buy near support levels when ADX is below 25 and sell near resistance levels when ADX is below 25. Alternatively, traders can use +DI and -DI crossovers as entry and exit signals within a range.
What Is the Difference Between the ADX and the DMI Indicators?
The main difference between the ADX and the DMI is that the ADX is non-directional, while the DMI is directional. The ADX only tells you how strong a trend is, but not which way it is going. The DMI tells you both the strength and the direction of a trend, by comparing the +DI and -DI values.
FAQ
The purpose of using the ADX and the DMI indicators is to identify and trade with the prevailing trend in the market. The ADX and the DMI can help traders determine whether the market is trending or ranging, whether the trend is bullish or bearish, and whether the trend is strong or weak.
The ADX and the DMI values can be interpreted as follows:
• When ADX is above 25, it indicates a strong trend. When ADX is below 25, it indicates a weak or non-trending market.
• When +DI is above -DI, it indicates an uptrend. When -DI is above +DI, it indicates a downtrend.
• When +DI crosses above -DI, it signals a bullish trend reversal. When -DI crosses above +DI, it signals a bearish trend reversal.
• When ADX rises above both +DI and -DI, it indicates a very strong trend.
The ADX and the DMI indicators are calculated as follows:
• Calculate the +DI, -DI, and True Range (TR) for each period. The TR is the greatest of the current high minus the current low, the current high minus the previous close, or the current low minus the previous close.
• Smooth the 14-period averages of +DI, -DI and TR using Wilder’s smoothing technique. The formula for smoothing TR is:
First 14TR = Sum of first 14 TR readings.
Next 14TR value = First 14TR – (Prior 14TR / 14) + Current TR
• Divide the smoothed +DI value by the smoothed TR value to get +DI. Multiply by 100.
• Divide the smoothed -DI value by the smoothed TR value to get -DI. Multiply by 100.
• Calculate the Directional Movement Index (DX) as:
DX = (+DI – -DI) / (+DI + -DI)
Multiply by 100 and take the absolute value.
• Smooth the DX values using Wilder’s smoothing technique to get ADX. The formula for smoothing DX is:
First ADX = sum of first 14 DX values / 14
Next ADX value = ((Prior ADX x 13) + Current DX) / 14
The ADX and the DMI indicators can be used in various ways to enhance trading decisions. Here are some examples:
• Trend-following strategies: Traders can use ADX and DMI to identify strong trends and trade in their direction. For example, traders can enter long positions when +DI is above -DI and ADX is above 25, and exit when either condition changes. Conversely, traders can enter short positions when -DI is above +DI and ADX is above 25, and exit when either condition changes.
• Trend-reversal strategies: Traders can use ADX and DMI to identify potential trend reversals and trade against them. For example, traders can enter short positions when +DI crosses below -DI and ADX is above 25, and exit when either condition changes. Conversely, traders can enter long positions when -DI crosses below +DI and ADX is above 25, and exit when either condition changes.
• Range-bound strategies: Traders can use ADX and DMI to identify range-bound markets and trade within them. For example, traders can buy near support levels when ADX is below 25 and sell near resistance levels when ADX is below 25. Alternatively, traders can use +DI and -DI crossovers as entry and exit signals within a range.
The advantages of using the ADX and the DMI indicators are:
• They are easy to calculate and interpret.
• They are objective and consistent.
• They can be used in any time frame and any market.
• They can be combined with other technical indicators or tools.
Conclusion
The ADX and the DMI are two related indicators that measure the strength and direction of a trend. They can be used together or separately to identify trending or ranging markets, bullish or bearish trends, and trend reversals. Traders can use ADX and DMI to enhance their trading strategies and improve their risk-reward ratio.
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