The Directional Movement Index is a great technical tool that helps you see the direction of the market and whether the market is making gains or losses. That’s easy, you say – what’s the point of that? Well, the Directional Movement Index (DMI) lets you see the rate of change. This makes it very useful for showing a few things:
When the pace of gains is slowing,
When the rate of gains has peaked and is starting to reverse.
In summary, the DMI can help you spot a trend reversal early. Here is how it works.
The DMI calculation
The DMI is calculated this way. It is a lengthy explanation, so follow this link for the calculation. However, the bottom line is that the DMI gives a visualised measure meant for the rate of gains. When the +DM is rising and crosses the -DM then gains are outpacing losses. When the -DM is rising and crosses the +DM then falls are outpacing gains. Take a look here for an example in silver.
Looking above at the first cross marked 1 you can see that the pace of gains clearly outpaces that pace of falls over the last 14 day period (see calculation methodology in link above). This would provide a decent entry in a trending market. Similarly, looking at the cross marked 2 you can see that the pace of falls is outpacing gains and that would have provided a good entry on the sell side.
The real world application
Now it is easy to use any indicator and ‘cherry pick’ dream entries. So traders must be aware when it is appropriate to use a tool and when it is not. The DMI is best used for trending markets. So, if there is a market that you think is fundamentally due for a nice trend then consider using the DMI as one of your tools. It can help with entry confirmation and give you another way of seeing the technical picture which has proved very helpful to some very successful traders.
High-Risk Investment Warning: Contracts for Difference (‘CFDs’) are complex financial products that are traded on margin. Trading CFDs carries a high degree of risk. It is possible to lose all your capital. These products may not be suitable for everyone and you should ensure that you understand the risks involved. Seek independent expert advice if necessary and speculate only with funds that you can afford to lose. Please think carefully whether such trading suits you, taking into consideration all the relevant circumstances as well as your personal resources. We do not recommend clients posting their entire account balance to meet margin requirements. Clients can minimise their level of exposure by requesting a change in leverage limit. For more information please refer to HYCM’s Risk Disclosure. *Any opinions made in this material are personal to the author and do not reflect the opinions of HYCM. This material is considered a marketing communication and should not be construed as containing investment advice or an investment recommendation, or an offer of or solicitation for any transactions in financial instruments. Past performance is not a guarantee of or prediction of future performance. HYCM does not take into account your personal investment objectives or financial situation. HYCM makes no representation and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast, or other information supplied by an employee of HYCM, a third party, or otherwise. Without the approval of HYCM, reproduction or redistribution of this information isn’t permitted.