Discover the Power of Wilder’s DMI (ADX) Indicator
Wilder’s DMI (ADX) is a robust tool comprised of three indicators that gauge the strength and direction of a trend. It features three lines: ADX, DI+, and DI-. The ADX line quantifies trend strength, while DI+ and DI- indicate the price direction. The typical color scheme assigns black to ADX, green to DI+, and red to DI-, though these colors are customizable. A higher ADX value signifies a stronger trend.
The Plus Direction Indicator (DI+) shows upward price momentum when it is above DI-. Conversely, the Minus Direction Indicator (DI-) reveals downward price momentum when it is above DI+.
Key Takeaways
- The DMI integrates three indicators: +DI, -DI, and ADX.
- Crossovers of +DI and -DI lines can serve as trade signals, measuring price movement.
- ADX indicates the trend’s strength with values above 25 signaling a strong trend.
Calculating Wilder’s DMI (ADX) for Precision
Steps to calculating the components:
- Compute +DM, -DM, and True Range (TR) for each period (typically 14).
- Define +DM as Current High - Previous High, and -DM as Previous Low - Current Low, picking the larger value of each.
- Identify TR as the highest among Current High - Current Low, Current High - Previous Close, and Current Low - Previous Close.
- Calculate the 14-period averages of +DM, -DM, and TR.
- Smooth TR with formulas: First 14TR = Sum of first 14 TR values, Next 14TR = First 14TR - (Prior 14TR / 14) + Current TR.
- Acquire +DI by dividing the smoothed +DM by the smoothed TR, then multiply by 100. Do the same for -DI.
- Identify DX by calculating the difference between +DI and -DI, divided by their sum, all in absolute terms, and multiply by 100.
- Obtain ADX by averaging DX values over at least 14 periods and smoothing the results continuously.
Interpreting Trend Signals with Wilder’s DMI (ADX)
Wilder introduced the DMI in 1978 to highlight trend strength, using values between zero and 100. ADX values are key to identifying trend strength:
- If DI+ > DI- and ADX > 25, expect a robust uptrend.
- If DI- > DI+ and ADX > 25, indicate a solid downtrend.
Traders can customize the ADX threshold based on market conditions, using 20 for earlier alerts or 30 for a conservative strong trend.
Advanced Trading with Wilder’s DMI
DI Crossovers
Traders might enter a long position when DI+ overtakes DI-, placing a stop-loss below the day’s low or a recent swing low. Conversely, DI- crossing above DI+ could signal a short position with a stop above the day’s high or a recent swing high. Ensuring an ADX above 25 confirms trend strength.
DI Contractions and Expansions
DI lines that diverge indicate increasing volatility, helpful for short-term traders, while convergence can signal low volatility, possible reversal, and breakout opportunities for swing traders.
Real-World Example of Wilder’s DMI (ADX)
Consider Shopify Inc. (SHOP): here’s a chart illustrating crossover and contraction scenarios where DI and ADX lines indicated viable trades. ADS values above 25 (or a set threshold) can trigger buy/sell signals and highlight periods of volatility contraction followed by trending movement.
However, DMI can produce false signals. Consider using it alongside other forms of analysis for better trade confirmation.
Comparing Wilder’s DMI (ADX) with the Aroon Indicator
While both DMI and Aroon involve crossover signals, DMI focuses on price movement by smoothing fluctuations. Aroon discusses the time since highs or lows over the watch period.
Limitations and Cautions Using Wilder’s DMI (ADX)
Primarily based on historical data, DMI may lag and thus may signal trades too late. Trends flashing a reading of 20-30 don’t guarantee persistence, and the indicator won’t predict future movement, only retrospectively confirm it occurred. Possible whipsaws necessitate cautious application and amalgamating signals with other technical indicators.
Related Terms: Aroon Indicator, Lagging Indicator, Stop-Loss Order, Price Action, Swing Trading.
References
- J. Welles Wilder. “New Concepts in Technical Trading Systems”. Trend Research, 1978.
