The Basics Of ADX/DMI

The Average Directional Index (ADX) and the Directional Movement Index (DMI) are technical indicators developed by J.Welles Wilder in the 1970s.  DMI measures the strength of a stock\'s current trend, positive or negative.  Basically, DMI is an oscillator, which bounces between 0 and 100.  DMI is usually broken down into DMI and DMI-, which are the postive and negative (bullish and bearish) readings.  There are many ways to analyze DMI readings, but the most common include crossovers (of postiive over negative and vice-versa), movements from extreme levels, and the difference between DMI and DMI-.

Another use for the DMI is to identify potential changes in a stock, from trending to non-trending.  An illustration would be a stock\'s DMI strengthens from lower than 20 to more than 20 - this could be read as a sign that the stock is about to break out of its trading range and start a trend.  Which direction?  That is often where other technical indicators come into play (such as Moving Averages, Percent R, etc).

Where does the ADX come from?  It is derived from the Positive Directional Indicator (DMI ) and the Negative Directional Indicator (DMI-).  The ADX melds these two indicators and smooths out the data with a moving average, which gives the analyst an idea of the strength of the trend.  Many think that crossovers of the 40 level on ADX indicate a strengthening or weaking of the underlying trend.  Remember this does not determine the trend itself, only the strength of the trend.

In the chart below, the green line is DMI and DMI- is red, ADX is the black line.

Don\'t let all the abbreviations confuse you, most refer to this indicator as the ADX/DMI, but you may see these indicators listed under their individual names or DI /DI-, Wilder\'s Directional Movement Index, etc.  Bottom line:  this tool is valuable because it can indicate the strength of an overall trend (remember the old adage \"the trend is your friend\").  In addition, it can indicate when a stock may be snapping out of a trading range, or when it is entering a trading range.  Also breaking down the strength of the positive trend versus the strength of the negative trend (and crossovers, difference range, etc) can be valuable.  DMI can be used by itself, as can ADX, and they also can be utilized in conjunction with each other and/or with other technical indicators.

Scott Downing, Analyst & Coach
with BigTrends Research

www.bigtrends.com

At BigTrends.com, we monitor the stock market to provide you with the best trading results possible. At a minimum, that means helping you outperform the major market indexes.

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