Directional Movement Index (DMI)
MG Financial Group recently launched the latest version of our
Charts & News software, which offers several new features including a floating ticker box, MACD alerts and the new Directional Movement Index (DMI) indicator. We would like to take this opportunity to discuss the DMI indicator in detail to enable our traders to make the best use of the enhanced charts software.
The Directional Movement Index (DMI) helps to determine the trend presence in the market. It consists of a total of three lines: Average Directional Movement Index (ADX) line, which is plotted between 0 to 100, the positive Directional Index (+DI) and the negative Directional Index (-DI) line. + DI measures the upward (positive) movement and the -DI measures the downward (negative) movement in a currency pair.
The Charts plot the DMI by defaulting to a 14-day period but you can customize these parameters to your preferences. The ADX Smooth # is defaulted to 44 periods and again, you can customize these parameters to your preferences.
The Trend is Your Friend
A numerically high ADX line signifies that the market is strongly trending while a relatively low ADX line shows a lightly trending market. For reference purposes, in his book,
Technical Analysis in the Global Currency Markets, Cornelius Luca suggests that a reading below 25 is a strong warning of a non-trending market and an ADX reading above 40 is a signal that the trend is strengthening. Keep in mind, however, that an ADX line below the 40-level is often regarded as a warning signal that the trend is weakening while a movement back above the 20 mark is treated as the possible start of a new trend.
As you can see in the picture above, a rising ADX line is shown by the yellow dotted line, which corresponds with a strong trending presence in the decline of GBP/USD. This is shown by the rectangular red box that captures both the rising ADX line and the sharp drop in the currency.
The yellow circle pointed out by the arrow in the lower half of the picture highlights the crossing of the ADX line below the 40 mark. A non-trending movement in the currency follows this crossing of the ADX line shown by the horizontal channel formed by the red lines in the upper half of the picture.
The signals to buy and sell are generated when the DI lines cross each other. A Buy signal is generated when the +DI crosses (blue line) over the -DI line (purple line). A sell signal is produced when the + DI line crosses below the -DI line.
As it can be seen from the picture above when the + DI line crosses the -DI line and moves below it, a Sell signal is generated, as illustrated by the red arrow. The Sell signal also corresponds with a trending downward movement in the currency. On the other hand, a Buy signal is produced when the +DI crosses the -DI and moves above.
In conclusion, the DMI's ADX indicator signals the strength of a trend in a currency. To review, a rising ADX line signifies that the market is trending sharply while a falling ADX line shows a non-trending environment. Further, the intersection of the positive and the negative DI lines generate the actual signals to buy or sell a currency pair by spotting trends in their infancy stages.
References:
� Luca,
Technical Analysis Applications in the Global Currency Markets, 1997
� Murphy,
Technical Analysis of the Financial Markets, 1999
These articles are designed to help traders understand the unique benefits of trading with DealStation. Articles contain hypothetical examples that have been created for illustration purposes only.
The opinion of the writer does not necessarily represent the view of MG and must be considered as an opinion and not fact.
