ADX / DMI

Directional Movement Indicator

Presented by
Sid Kotha – Jan 2005
 INDICATOR DATA
• Indicator
All indicators in technical analysis are built
from the same source of raw data:
the opening price
the closing price
the highest price of the day
the lowest price of the day
number of shares traded
 TYPES OF INDICATORS
• Trend indicators
Ex: moving averages, ADX are used to
indicate the direction of a trend;
• Momentum indicators measure the speed
at which price is changing;
• Volume Indicators are used to confirm the
strength of trends;
• Volatility Indicators confirm price behavior.
 ADX / DMI
• The Directional Movement System is a fairly
complex indicator developed by Welles Wilder.
One of the oldest indicator, originally developed
in 1978. (Book: New Concepts in Technical
Trading Systems.)
• Most indicators have one major weakness - they
are not suited for use in both trending and
ranging markets. The key feature of the
Directional Movement System is that it first
identifies whether the market is trending before
providing signals for trading the trend.
 DEFINITION
• Directional Movement System measures the
ability of bulls and bears to move price outside
the previous day's trading range. The system
consists of three lines:
• The Positive Direction Indicator (+DI)
summarizes upward trend movement;
• The Negative Direction Indicator (-DI)
summarizes downward trend movement; and
• The Average Directional Movement Index (ADX)
indicates whether the market is trending or
ranging.
 Additional Resources
• http://www.esignal.com/education/likepro/s
trategy/volume/default.asp
• www.stockcharts.com
• www.incrediblecharts.com
 Simple Trading System based on ADX by
Dr. Alexander Elder
Go long when +DI is above -DI and either:
• ADX rises while +DI and ADX are above -DI; or
• ADX turns up from below +DI and -DI.
• Exit when +DI crosses below -DI.

Go short when -DI is above +DI and either:

• ADX rises while -DI and ADX are above +DI; or
• ADX turns up from below +DI and -DI.
• Exit when -DI crosses below +DI.
 RISK MANAGEMENT

Use stop-losses at
all times.
 OVERALL GUIDELINES
• ADX:
• Declining ADX shows that the market is losing direction.
When ADX falls below both +DI and -DI it signals a
lifeless market.
• Dr Elder suggests waiting until ADX rises 4 steps off its
low (e.g. ADX rises to 19 from a low of 15). The longer
that ADX has remained below both +DI and -DI the
stronger the subsequent trend is likely to be.
• When ADX rises above both +DI and -DI it signals that
the market is becoming overheated.
 BUILDING THE ADX INDICATOR
• To calculate the Directional Movement System:
• Calculate the Directional movement for today
+DM = Today's High - Yesterday's High (when price moves upward)
-DM = Yesterday's Low - Today's Low (when price moves downward)
You cannot have both +DM and -DM on the same day. If there is an outside day (where both calculations are
positive) then the larger of the two results is taken. An inside day (where both calculations are negative) will
always equal zero.
• Calculate the true range for the day. True range is the largest of:
Today's High - Today's Low,
Today's High - Yesterday's Close, and
Yesterday's Close - Today's Low
• +DM14 = exponential moving average* of +DM
• -DM14 = exponential moving average* of -DM
• TR14 = exponential moving average* of True Range
Next, calculate the Directional Indicators:
• +DI14 = +DM14 divided by TR14
• -DI14 = -DM14 divided by TR14
Then, calculate the components of the Average Directional Movement Index (ADX):
• Calculate the DI Difference:
Record the difference between +DI14 and -DI14 as a positive number.
• Calculate the Directional Index (DX):
DX = DI Difference divided by the sum of +DI14 and -DI14
• ADX = the exponential moving average* of DX
EXAMPLES
 EXPERTS COMMENTS
Paul Rabbitt
A rising ADX but only at the 15 to 20 level
is a weak momentum situation. If above
30, it is a stronger momentum.
Even if ADX changes direction as long it is
above 30, it is strong.
 L. Raschke
• LINDA uses DAILY CHARTS for her ADX trading

• She uses color coded charts: (Women are from Venus, even if they are traders !!!)
ADX in her trading system changes colors as follows:
from Linda)
(may be Tom Ridge got a clue

ADX under 20, between 20 and 30, above 30

ADX above 30 and DMI + above DMI –ve color is GREEN

SAME AS ABOVE- but DMI – above + DMI, color is RED

However, once the above is confirmed she waits for a price

Reaction, i.e. pull back for long or rally for a short.
 L. RASCHKE
• Her comments are:
ADX being above 30 signifies that there is a strong
trend on the time frame you are looking at. And
if the ADX rises high enough, then any reaction
should trigger a retest of sorts about 80% of the
time. It comes from the generic technical
analysis principle that momentum preceeds
price. If there is strong-enough momentum, the
price extreme is still yet to come.
 L.Raschke’s HOLY GRAIL
Trading Rules
a. The 14 unit ADX must be above 30 to signify a strong
trend in progress
b. When ADX forms a top and begins to turn down, look
for a retracement that causes price to move towards
the 20-unit EMA
c. In an uptrending market, look to buy when price falls to
or near the 20 unit EMA. In a downtrending market,
look to sell when price rises to or near its 20 unit EMA.
ADX is a lagging indicator in some sense because it has
too much smoothing
 TRENDING or NON-TRENDING
TRENDING:
if ADX < 25 and rising
if ADX > 30
Use your moving averages for entry / exits

Non-Trending:
if ADX < 20, use oscillators
if ADX < 30 and declining, use oscillators