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Trading with the Directional Movement System (DMS)

Utility: Evaluating the Trend

Standard Settings: 14 Periods

The Directional Movement System was developed by Welles Wilder. The indicator was presented on the book “New Concepts in Technical Trading Systems”. What distinguishes Directional Movement System from other systems is that it first evaluates if a market is trending before offering trading signals. The default settings for the indicator involves 14 periods.

 

The Directional Movement System consists three lines:

(a) The Positive Direction Indicator (+DI) which summarizes the upward trend movement

(b) The Negative Direction Indicator (-DI) which summarizes the downward trend movement

(c) The Average Directional Movement Index (ADX) which indicates whether the market is trending or ranging.

Trading with the Directional Movement System (DMS)

 

Calculating the Directional Movement System:

First we must calculate the today’s Directional movement

■ +DM = Today's High - Yesterday's High (when the market moves upward)
■ -DM = Yesterday's Low - Today's Low (when the market moves downward)

After we calculate the True Range for the day.

■ Today's High - Today's Low
■ Today's High - Yesterday's Close
■ Yesterday's Close - Today's Low

Next, we calculate +DM14

■+DM14 = exponential moving average of +DM

Next, we calculate -DM14

■ -DM14 = exponential moving average of -DM

Next, we calculate TR14

■ TR14 = exponential moving average of True Range

After we calculate the Directional Indicators:

■ +DI14 = +DM14 / TR14

■ -DI14 = -DM14 / TR14

Finally we calculate the parts of ADX (Average Directional Movement Index)

■ Calculate the DI Difference (+DI14 and -DI14) as a positive number.

■ Calculate the Directional Index (DX):
DX = DI Difference / (sum of +DI14 and -DI14)

■ ADX = the exponential moving average of DX

 

GKFX -London-Based ECN Forex Broker

 

Explaining the ADX (Average Directional Movement Index)

□ If ADX declines that is a signal that the market is losing direction.

□ If the value of ADX moves below both +DI and -DI then that is a very bad signal regarding the upcoming market conditions

□ The more time ADX remains below both +DI and -DI then the stronger the new trend shall prove.

□ If ADX moves above both +DI and -DI then it is a signal that the market becomes overbought.

□ It is better to wait until ADX rises 4 steps off its low and then trade (for example if the low=17 wait until ADX=21)

 

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Directional Movement System (DMS)

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