Directional Movement index (DMI or DX)
DMI filtrates on price exchange rates lays in the basis and let's enter the market only if substantial trends exist. It is developed for increasing the strength of all upward or downward trends in the Forex trading market. The Directional Movement Index consists of Average Directional Index, or ADX, which defines the strength of the trend; DI+ and DI, which demonstrate the strength of the decreasing and increasing prices correspondingly. ADX is a moving average of Directional Index, or DX, with a smoothing constant makes time period selected for calculating upward and downward fluctuations twice as long.
1. N - the period of averaging
1. Calculation of the positive and negative directional movement - DM - +DMj and-DMj
if Highj> Highj-1, +DMj = Highj - Highj-1, differently +DMj = 0
if Lowj < Lowj-1, -DMj = Lowj-1 - Lowj, differently-DMj = 0
Smaller value from +DMj and -DMj is equated to zero. If they are equal, both are equated to zero.
2. Calculation of the true range- TRj
TRj = max (|Lowj - Closej-1 |, |Highj - Closej-1 |, |Highj - Lowj |)
3. Calculation of a positive directional index and the negative directional index - +DIj and -DIj
If TRj = 0, +SDIj = 0, -SDIj = 0,
if TRj 0, +SDIj = +DMj / TRj; -SDIj =-DMj / TRj
Smoothing +SDI and -SDI by exponentional moving average (EMAve), we receive +DIj and -DIj
+DIj = EMAvej (+SDI, N)
-DIj = EMAvej (-SDI, N)
4. Calculation of the directional movement - DXj:
DXj = (| +DIj --DIj | / | +DIj +-DIj |)
In a trading system with DMI in the centre, there is a purchase signal when the DI+ value overcomes the DI-, and for a sell signal, search the point in which DI exceeds DI+. Both Forex trading signals are given only if there is a rather strong trend- for instance, if the value of ADX is more than 25%.
How does the Directional Movement Index give the opportunity to define if a currency is trending? The main Directional Movement system compares the 14-day +DI, the so-called Directional Indicator, to the 14-day -DI. There are 2 ways to do it: by subtracting the +DI from the -DI or by placing the both indicators on top of each other. When the +DI exceeds the -DI specialists advice to purchase and when the +DI is under the -DI it is better to sell. They name these easy trading rules "extreme point rule" which is developed to prevent whipsaws and lower the deals' number.
According to the extreme point rule the "extreme point" is set on the day when the +DI and -DI cross. The extreme price is the low price on the day the lines cross when the +DI becomes less than the -DI. The extreme price is the high price on the day the lines cross when the +DI is over the -DI. Afterwards the extreme point is like a start signal at which you should execute trade deals.
For instance, when the +DI rises above the -DI (which is a clear purchase signal), you should wait a little before purchasing until the security's price rises above the extreme point - when the high price on the day that the +DI and -DI lines crossed. In case the price does not move over the extreme point, it is better if a dealer foes on keeping up to the short position.