When surfers scan the vast expanse of the ocean, they are looking for the wave whose direction and pull assure them of an exhilarating ride. But how do surfers know which building upsurge of water won't amount to much while others that look the same to beginners will pick them up and carry them in? The answer lies in reading the direction and strength of the waves, much like how traders navigate the financial markets. Enter the directional movement index (DMI), which is often a trusted way for technical analysts and traders to do much the same with the pricing currents of the market. The DMI helps them determine the strength and direction of price trends. Developed by J. Welles Wilder in 1978, the DMI identifies the direction in which an asset price is moving. The DMI does this by comparing earlier highs and lows and drawing two lines: a positive directional movement line, called "+DI," and a negative directional movement line, called "-DI." A third line, the average directional index (ADX), can also gauge the strength of upward or downward trends.

When +DI is above -DI, the price has more upward pressure than downward pressure. Conversely, if -DI is above +DI, the price has more downward pressure. This helps traders assess the trend direction. Crossovers between the lines are also used as signals to buy or sell. Below, we show you how to employ the DMI in trading, compare it to other indicators, and review some of its limits.

Formulas for the Directional Movement Index (DMI)

 $\begin{aligned} &\text{+DI} = \left ( \frac{ \text{Smoothed +DM} }{ \text{ATR } } \right ) \times 100 \\ &\text{-DI} = \left ( \frac{ \text{Smoothed -DM} }{ \text{ATR } } \right ) \times 100 \\ &\text{DX} = \left ( \frac{ \mid \text{+DI} - \text{-DI} \mid }{ \mid \text{+DI} + \text{-DI} \mid } \right ) \times 100 \\ &\textbf{where:}\\ &\text{+DM (Directional Movement)} = \text{Current High} - \text{PH} \\ &\text{PH} = \text{Previous high} \\ &\text{-DM} = \text{Previous Low} - \text{Current Low} \\ &\text{Smoothed +/-DM} = \textstyle{ \sum_{t=1}^{14} \text{DM} - \left ( \frac{ \sum_{t=1}^{14} \text{DM} }{ 14 } \right ) + \text{CDM} } \\ &\text{CDM} = \text{Current DM} \\ &\text{ATR} = \text{Average True Range} \\ \end{aligned}$​+DI=(ATR Smoothed +DM​)×100-DI=(ATR Smoothed -DM​)×100DX=(∣+DI+-DI∣∣+DI−-DI∣​)×100where:+DM (Directional Movement)=Current High−PHPH=Previous high-DM=Previous Low−Current LowSmoothed +/-DM=∑t=114​DM−(14∑t=114​DM​)+CDMCDM=Current DMATR=Average True Range​

Calculating the Directional Movement Index

1. Calculate +DM, -DM, and the true range (TR) for each period. Typically, 14 periods are used.
2. +DM is the current high minus the previous high.
3. -DM is the previous low minus the current low.
4. Use +DM when the current high minus the previous high is greater than the previous low minus the current low. Use -DM when the previous low minus the current low is greater than the current high minus the prior high.
5. The TR is the greater of the current high minus the current low, the current high minus the previous close, or the current low minus the previous close.
6. Smooth the 14-period averages of +DM, -DM, and the TR. Below is the formula for TR. Insert the -DM and +DM values to calculate the smoothed averages of these as well.
7. First 14TR = Sum of the first 14 TR readings.
8. The next 14TR value = First 14TR - (Prior 14TR/14) + Current TR
9. Next, divide the smoothed +DM value by the smoothed average true range (ATR) value to get +DI. Multiply this by 100.
10. Divide the smoothed -DM value by the smoothed TR value to get -DI. Multiply this by 100.
11. The optional directional index (DX) is +DI minus -DI, divided by the sum of +DI and -DI (all absolute values). Multiply this by 100.
12. The average directional movement index (ADX) is a smoothed DX average, another indicator that can be added to the DMI. To get the ADX, continue to calculate DX values for at least 14 periods. Then, the results will be smoothed to get ADX.

What Does the Directional Movement Index Tell You

The DMI is primarily used to help assess trend direction and provide trade signals.

Crossovers are the main trade signal. A long trade is taken when the +DI crosses above the -DI and an uptrend could be underway. Meanwhile, a sell signal occurs when the +DI instead crosses below the -DI. In such cases, a short trade may be initiated because a downtrend might be underway.

The indicator can also be used as a trend or trade confirmation tool. If the +DI is well above -DI, the trend has strength on the upside, and this would help confirm current long trades or new long trade signals based on other entry methods. Conversely, if -DI is well above +DI, this confirms a strong downtrend or short positions.

The Directional Movement Index vs. the Aroon Indicator

While the DMI and the Aroon indicator are both technical analysis tools used to identify the direction and strength of a market trend, they have distinct methods and ways of interpreting them.

Quick Overview of Aroon Indicator

The Aroon indicator is a technical analysis tool designed to identify changes and strength in a trend direction. Developed by Tushar Chande in 1995, it can be particularly useful for pinpointing the start of a new trend and discerning whether an asset is trending or trading sideways.

While the DMI and Aroon indicators aim to identify and analyze trends, they do so with different approaches and calculations. Traders may choose one over the other based on their trading style, market conditions, and analysis goals.

Limitations of the Directional Movement Index

The DMI is part of a larger system called the average directional movement index (ADX). The trend direction of DMI can be added to the strength readings of the ADX. Readings above 20 on the ADX mean the price is trending strongly. Whether using ADX or not, the indicator is still prone to producing false signals.

Notably, +DI and -DI readings and crossovers are based on historical prices and don't necessarily reflect what will happen. A crossover can occur, but the price may not respond, resulting in a losing trade.

Lines can also crisscross, resulting in multiple signals but no price trend. This can be avoided by only taking trades in the larger trend direction based on long-term price charts or incorporating ADX readings to help isolate strong trends.

An Example of Using the DMI

This example uses the DMI on the stock for Microsoft Corporation (). The historical testing was done for the year between Feb. 27, 2023, and Feb. 26, 2024. The buying condition occurs when the +DI crosses above the -DI. This would close out any short positions. Conversely, the sell condition occurs when the +DI crosses below the -DI. This condition will close out any long positions. The trading strategy assumptions for the DMI include the following:

• Initial capital of $1 million
• Order size of 100% of equity
• No pyramiding of orders
• No leveraged trades
• Commissions, slippage, and taxes are ignored
• Period length of 14

The results are as follows:

• Net profit: 6.95%
• Total closed trades: 11
• Percentage of profitable trades: 45.45%
• Profit factor generated: 1.602
• Maximum drawdown: 9.47%
• Buy and hold over same period: 22.81%

This example illustrates the potential effectiveness of the DMI. However, it is critical to note that traders typically use more complex trading strategies and leverage, and they subject technical analysis indicators to more extensive backtesting and optimization with many securities before applying any to real trading.

The Bottom Line

The DMI is a helpful technical analysis tool developed to identify the direction and strength of a price trend. The indicator consists of two primary components, the +DI and the -DI, along with the ADX, which measures trend strength. Calculating the DMI involves comparing consecutive highs and lows to determine the direction of price moves and then smoothing these differences over a given period to isolate the trend direction. The +DI and -DI are plotted alongside the ADX to represent trend direction and strength visually. Traders use the DMI to pinpoint entry and exit opportunities, gauge trend strength, and in broader trading strategies, often combining it with other indicators to enhance accuracy and reduce false signals. The DMI's ability to distinguish between strong and weak trends makes it indispensable for many traders, offering perspectives that can lead to more informed trading decisions.