Forex professionals have developed the Directional Movement Index (DMI) as a technical indicator. This indicator will help a trader to determine the movement of the price and will analyze and compare the highs and lows of the graph by pulling two lines. One of the lines will exhibit a positive movement and direction (+DI), while the other will show a negative direction (-DI). Sometimes, the indicator will produce a third line, which shows the difference between the positive and negative lines. This directional line is denoted by DX.
Interpreting the directional movement
When the positive directional movement index line is above the negative one (the +DI is above the -DI), it reveals that there is an uptrend in the market. When the -DI is above the +DI, then it indicates that there is a downward trend. Thus, the sign of this line helps assess the market’s condition. Besides this, sometimes, these two lines cross over one another, which indicates the time to buy or sell the currency.
During the upward movement of the market, the +DI line is above the -DI line, and when these two lines cross over, it indicates that investors should sell his currency because that’s the end of the uptrend. Similarly, during the downtrend, the -DI is above the +DI, and when these lines cross over, it indicates that traders in Hong Kong should buy the currency because this is the point where the bearish movement will stop, and bullish movement will take its place. To learn more about the stages of trend, you can read articles at Saxo and enhance your skills.
A trader can also determine the strength of the movement and can show a strong line, which is called the ADX (Average Directional Index). In most cases, the +DI and -DI have different colors. The Average Directional Index concentrates on the strength of a downward and upward trend. If an investor finds that the value of ADX is more than 25, it will indicate that the trend is quite strong, and if the value is less than 25, it will indicate that the market is moving sideways. According to the professionals, this DMI can be used in both trending and ranging markets.
Basic differences between the directional movement index and the Aroon indicator
Many beginners become too confused with these indicators because some of them think that both of them are the same, while others don’t realize the basic differences. The Directional Movement Index (DMI) will exhibit two lines, and there will be an optional line as well. On the other hand, the Aroon indicator will show only two lines. Both of them show positive and negative lines or movements, which will help a Forex trader identify the trend’s direction. The calculations of these indicators are different, and the crossovers will take place at various times. To recognize the difference, you should practice using these indicators often.
What are the limitations of using the directional movement index?
DMI is a part of greater system, which is called ADX. The direction of the trend can also be applied to observe the strength of the average directional movement index. However, keep in mind that whether you use the ADX or not, this indicator can still generate a wrong signal. Sometimes, the crossovers and readings don’t reflect the upcoming market’s condition. In certain cases, the crossover may occur, but the market price may not respond to the lines. The lines can also produce multiple crisscross and signals, but still, there can be no trend or movement in the chart.
The good thing is – anybody can bypass these problems by choosing trades in greater movement or trend direction, which is also called a longer timeframe. Choosing a longer time frame may go well with the DMI.
The DMI is indeed effective at determining the uptrend, downtrend, entry, and exit points. A trader can use this indicator to find out the favorable condition to enter or exit a market. You can practice using the DMI to enhance your skills and knowledge.