The Directional Movement Index (DMI) system, developed by J. Welles Wilder Jr., quantifies directional price movement. The Average Directional Index (ADX) measures trend strength. The Positive Directional Indicator (+DI) and Negative Directional Indicator (-DI) measure upward and downward pressure. This lesson focuses on +DI and -DI, analyzing their crossover signals and divergence patterns. These indicators provide objective metrics for trend identification and reversal anticipation, crucial for intraday trading.
+DI and -DI Calculation and Interpretation
The +DI and -DI components derive from the Directional Movement (DM). Directional Movement compares the current high/low to the previous high/low.
Positive Directional Movement (+DM) occurs when the current high exceeds the previous high, and the current low does not exceed the previous high. Specifically, +DM = Current High - Previous High, only if (Current High - Previous High) > (Previous Low - Current Low) and (Current High - Previous High) > 0. Otherwise, +DM = 0.
Negative Directional Movement (-DM) occurs when the current low falls below the previous low, and the current high does not fall below the previous low. Specifically, -DM = Previous Low - Current Low, only if (Previous Low - Current Low) > (Current High - Previous High) and (Previous Low - Current Low) > 0. Otherwise, -DM = 0.
When the market moves up, +DM registers. When the market moves down, -DM registers. Both cannot register simultaneously. If the range expands but neither condition is met, both +DM and -DM are zero.
Next, we smooth the +DM and -DM values, typically over 14 periods, using a Wilder's smoothing method. This produces +DM14 and -DM14.
True Range (TR) measures market volatility. TR is the greatest of three values:
- Current High - Current Low
- Absolute value of Current High - Previous Close
- Absolute value of Current Low - Previous Close
We then smooth TR over 14 periods to get TR14.
Finally, we calculate +DI and -DI: +DI = (+DM14 / TR14) * 100 -DI = (-DM14 / TR14) * 100
These lines oscillate between 0 and 100. A rising +DI suggests increasing upward pressure. A rising -DI indicates increasing downward pressure.
For intraday trading, a 5-minute or 15-minute chart provides sufficient granularity. On a 5-minute ES chart, a +DI reading above 25 indicates a strong bullish directional bias. A -DI reading above 25 indicates a strong bearish directional bias. When +DI is above -DI, buyers control the short-term direction. When -DI is above +DI, sellers dominate.
Institutional algorithms frequently incorporate DMI components. Large hedge funds and proprietary trading firms use these indicators for trend confirmation and counter-trend entry identification. Algos scan for +DI/-DI crossovers in conjunction with other momentum indicators like RSI or MACD. A common institutional strategy involves filtering trades: only taking long positions when +DI > -DI and ADX > 20, and short positions when -DI > +DI and ADX > 20. This reduces false signals in choppy markets.
Trading Strategies with +DI and -DI
Crossover Strategy
The most common application involves +DI and -DI crossovers.
Bullish Crossover: +DI crosses above -DI. This signals increasing upward momentum. A buy signal generates. Bearish Crossover: -DI crosses above +DI. This signals increasing downward momentum. A sell signal generates.
For enhanced reliability, combine crossovers with ADX. A crossover signal gains strength when ADX is above a certain threshold, typically 20 or 25. An ADX below 20 suggests a non-trending or range-bound market, where crossovers often produce whipsaws.
Example: NQ (Nasdaq 100 Futures) 5-minute Chart
Assume NQ trades sideways for 30 minutes. ADX hovers around 15. At 10:30 AM EST, NQ breaks above a short-term resistance level. +DI (14) crosses above -DI (14). Simultaneously, ADX (14) rises from 18 to 26.
This confirms a developing trend. A trader might enter a long position on the candle close after the crossover and ADX confirmation.
Worked Trade Example: NQ Long
- Instrument: NQ (Nasdaq 100 Futures)
- Timeframe: 5-minute chart
- Entry Signal: +DI crosses above -DI, and ADX rises above 25.
- Entry Price: NQ trades at 18,250. Enter long 2 contracts at 18,250.
- Stop Loss: Place stop below the swing low preceding the crossover, or 1.5 ATR (Average True Range). If ATR is 15 points, stop at 18,227.5 (18,250 - 1.5 * 15).
- Target: Aim for a 2R profit. Risk per contract is 22.5 points. Total risk = 2 contracts * 22.5 points/contract * $20/point = $900. Target profit = $1,800 or 45 points per contract. Target price = 18,250 + 45 = 18,295.
- R:R Ratio: 2:1*
This strategy works best in trending markets. During periods of low volatility or range-bound trading, crossovers generate numerous false signals. A prop trader would typically use a higher ADX threshold (e.g., 30) for trend entries on higher timeframes (15-min or 30-min) to filter out noise.
Divergence Strategy
Divergence between price and +DI/-DI can signal potential reversals.
Bullish Divergence: Price makes a lower low, but +DI makes a higher low (or -DI makes a higher low, indicating less downward pressure). This suggests weakening bearish momentum and potential for an upward reversal. Bearish Divergence: Price makes a higher high, but -DI makes a lower high (or +DI makes a lower high, indicating less upward pressure). This suggests weakening bullish momentum and potential for a downward reversal.
Divergence is a counter-trend strategy. It carries higher risk but offers earlier entry points for reversals. Confirm divergence with other indicators like volume spikes or candlestick patterns (e.g., engulfing patterns, hammers).
Example: AAPL (Apple Inc.) 15-minute Chart
AAPL stock price makes a new intraday low at $170.50. However, the -DI line on the 15-minute chart makes a higher low compared to its previous low when AAPL was at $171.00. +DI remains low. ADX is below 20.
This bearish divergence on -DI suggests selling pressure is waning, even as price pushes lower. A trader might look for a reversal candlestick pattern, like a bullish engulfing candle, to confirm a long entry.
Considerations for Divergence:
- Timeframe: Divergences on higher timeframes (e.g., 60-min, daily) hold more significance than on 1-min charts.
- Confirmation: Never trade divergence in isolation. Always seek confirmation from price action, volume, or other momentum oscillators.
- ADX Context: Divergence signals are more reliable when ADX is low, indicating a non-trending market ripe for a reversal. If ADX is high, the trend is strong, and divergence might simply be a pause before continuation.
When +DI and -DI Fail
+DI and -DI, like all indicators, are not infallible.
- Choppy/Range-Bound Markets: When the market lacks a clear trend, +DI and -DI frequently cross over, generating false signals. ADX below 20 (or 25) indicates such conditions. Trading crossovers in these environments leads to whipsaws and losses. For example, if SPY trades between $450 and $452 for two hours, +DI and -DI will likely oscillate around each other without sustained separation, leading to multiple failed entries.
- Lagging Nature: As derived indicators, +DI and -DI inherently lag price action. Crossover signals often appear after a significant portion of the move has already occurred. This reduces the profit potential and increases risk. A sudden news event can cause a rapid price spike or drop, and the DMI system will only register the trend after a few periods, missing the initial, most profitable move.
- Extreme Volatility: During periods of extreme volatility, such as earnings announcements or Fed rate decisions, price can move erratically. Wicks become long, and ranges expand dramatically. +DI and -DI can give conflicting signals or lag excessively, making them unreliable. For instance, CL (Crude Oil Futures) can experience 200-tick swings in minutes during inventory reports, rendering DMI signals almost useless for precise entry.
- Over-optimization: Adjusting the lookback period (e.g., from 14 to 1
