J. Welles Wilder established the directional movement index (DMI) in 1978 to determine the direction in which the price of an asset is moving. This is accomplished by the indicator analyzing prior highs and lows and producing two lines: a positive directional movement line (+DI) and a negative directional movement line (-DI). The average directional index (ADX) is an optional third line that can be used to measure the strength of the uptrend or downturn.

When +DI is greater than -DI, the price has more upward pressure than downward pressure. If -DI is more than +DI, then there is greater downward pressure on the price. This indicator may aid traders in determining the direction of the trend. Crossovers between the lines are also occasionally utilized as buy or sell signals.

What Information Does the Directional Movement Index Provide?

Usually, the DMI is employed to analyze trend direction and also attempts to measure the strength of the trend.

Crossovers are the primary trading indicators. A buy signal is given when the +DI crosses above the -DI, indicating a possible upswing. In contrast, a sell signal is generated when the +DI crosses below the -DI. In such situations, a short position may be considered because a decline may be in progress.

The indicator can also be utilized as a confirmation tool for trends and trades. If the +DI is significantly greater than the -DI, the trend is bullish, and this would help confirm existing long trades or generate fresh long trade signals based on other entry approaches. In contrast, if -DI is significantly higher than +DI, this confirms a strong decline or short positions.

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Comparison of the Directional Movement Index to the Aroon Indicator

The DMI indicator consists of two lines, with a third line being optional. The Aroon indicator features two lines as well. Both of the indicators display positive and negative movement, facilitating the identification of trend direction.

Yet, since the computations are distinct, the crossovers for each indicator will occur at separate times.

What Is the Limitation of The Directional Movement Index?

The DMI is a component of the average directional movement index system (ADX). The DMI trend direction can be combined with the ADX strength measurements. Readings above 20 on the ADX indicate a strong price trend. Whether or not ADX is employed, the indicator is still susceptible to creating many false signals.

Note that +DI and -DI readings and crossovers are based on historical price data and may not indicate future events. The price may not respond to a crossover, resulting in a negative transaction.

The lines may also intersect, producing many indications but no price trend. This can be avoided in part by simply trading in the direction of the wider trend based on long-term price charts or by integrating ADX readings to assist in identifying powerful trends.

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*This article discusses technical analysis, other approaches, including fundamental analysis, may offer very different views. The examples provided are for illustrative purposes only and are not intended to be reflective of the results you can expect to achieve. Specific security charts used are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.Please note when short selling there is no limit on how high a stock price could rise so the potential loss is unlimited. Other risks include dividend risk and margin risk, this strategy is not appropriate for all investors.