The DMI trading strategy is often known on most trading platforms by its third component, the average directional index (ADX). Not many know what the DMI is. Let’s take a look at it.
The DMI (directional movement index) is a trend indicator that shows the strength of a trend, irrespective of the direction. It has two main components: a positive directional movement line (+DI), which measures the changes in price high, and a negative directional movement line (DI) which tracks the price lows. There is also an optional third line, the ADX line, which can also be used to gauge the strength of the uptrend or downtrend.
This article explains the DMI and at the end, we do a backtest to find out if you can use the DMI to make a trading strategy.
Table of contents:
What is the DMI DMI trading strategy?
The DMI (directional movement index) is a trend indicator that shows the strength of a trend, irrespective of the direction. It has two main components: a positive directional movement line (+DI), which measures the changes in price high, and a negative directional movement line (DI) which tracks the price lows.
The two components are used to gauge the strength of the uptrend or downtrend. They can be used to differentiate between strong and weak trends, so traders use the indicator to formulate momentumbased trading strategies. The indicator works on all time frames and can be used to trade any asset, including stocks and futures. While the indicator assists in determining if a security is trending and attempts to measure the strength of the trend, it disregards the direction of the security. It only attempts to determine if there is a trend and the strength of the trend.
In some platforms, the indicator is made up of four indicator lines:
 Positive directional movement indicator (+DMI): This shows the difference between today’s high price and yesterday’s high price. A 14period value is used to get the +DMI line.
 Negative directional movement indicator (–DMI). This shows the difference between today’s low price and yesterday’s low price, but the values are then summed up from the past 14 periods and plotted.
 Average Directional Index (ADX). This is a smoothing of the DX, which measures the difference between the +DMI and DMI
 Average Directional Movement Index Rating (ADXR): This is a simple average of today’s ADX value and the ADX from 14 periods ago.
When the levels of the ADX and ADXR are high and rising, it indicates a strong trend, either up or down. Typically, an ADX value of 25 is used as the threshold for a strong trend — if the ADX is above 25 it indicates a strong trend. On the flip side, low and falling levels of the ADX and ADXR indicate a trendless market. When the ADX is below 20 it indicates a trendless market (according to the theory).
What is the formula for DMI (trading strategy)?
The formulas for the directional movement index are given as follows:
+DMI = {Smoothed +DM/ATR} x 100
DMI = {Smoothed DM/ATR} x 100
DX = [(+DMI — DMI)/(+DMI + DMI)] x 100
Where:
+DM (Directional Movement) = Current High — Previous High
DM = Current Low — Previous Low
ATR = Average True Range
Note that the +DM and DM are smoothed over 14 periods. Also, note that the ADX is a smoothed version of the DX. To get the ADXR, you calculate a simple average of today’s ADX value and the ADX from 14 periods ago.
Who invented the DMI?
The DMI (trading strategy) and other components were developed in the 1970s (most likely 1978) by an American technical analyst, J. Welles Wilder, who is widely known for authoring “New Concepts in Technical Trading Systems” and developing the everpopular RSI indicator.
What does the DMI tell you?
The DMI tells you the momentum of the price action — when +DMI is above DMI, there is more upward pressure than downward pressure in the price, and when DI is above +DI, there is more downward pressure on the price. Thus, the indicator can be used to identify or confirm a trend. If the +DMI is well above DMI, the trend has strength on the upside. Conversely, if DMI is well above +DMI, it indicates a strong downtrend.
This indicator may also help traders determine the direction to trade, as crossovers between the lines are also sometimes used as trade signals to buy or sell. A long trade is taken when the +DMI crosses above the DMI and an uptrend could be underway. On the other hand, a sell signal occurs when the +DMI instead crosses below the DMI. In such cases, a short trade may be initiated because a downtrend might be underway.
The ADX indicator
As mentioned, the DMI is part of the ADX indicator.
We consider the ADX indicator to be a very underappreciated indicator and one of the most valuable indicator ever made. However, it doesn’t work so well on it’s own but must be used with other parameters. Furthermore, it doesn’t work so well in the “traditional” way as explained in the original book by Welles Wilder or shown on most websites. We use the ADX frequently among our monthly trading edges.
DMI trading strategy backtest
Let’s go on to backtest the DMI trading strategy and potentially find a trading strategy or strategies. We can reveal from the start that DMI doesn’t work on its own (both DMI+ and DMI) – just like the ADX indicator.
As usual, we did a twist to the DMI indicator to improve the result. Below we have a backtest and strategy on (SPY) that uses the DMI+ and another variable. The equity curve looks like this:
The number of trades since SPY’s inception in 1993 is 382, the average gain per trade is 0.55%, the win rate is 76%, the max drawdown is a modest 14%, and the profit factor is 2.6. We would say this is a pretty solid strategy and is unlikely to be a result of curve fitting.
We keep the trading strategy for our paying subscribers of monthly trading edges.
DMI (directional movement index) – ending remarks
The ADX indicator is not a standalone indicator, and so is the DMI. It requires some boost from other variables. However, it’s pretty powerful if you use it correctly!
FAQ:
What is the DMI (Directional Movement Index) Trading Strategy?
The DMI Trading Strategy is a trend indicator that measures the strength of a trend, regardless of its direction. It comprises two main components: the positive directional movement line (+DI) and the negative directional movement line (DI), which help traders assess the strength of uptrends and downtrends.
How does the DMI differ from other trend indicators?
Unlike many trend indicators, the DMI focuses on gauging the strength of a trend without considering its direction. It helps traders identify strong and weak trends, providing valuable insights for formulating momentumbased trading strategies.
What are the key components of the DMI (Directional Movement Index)?
The DMI has three main components: +DI (positive directional movement line), DI (negative directional movement line), and the optional ADX (Average Directional Index). These components work together to assess trend strength and differentiate between strong and weak trends.
As an experienced trader and enthusiast in technical analysis, particularly in trend indicators and trading strategies, I can confidently provide insights into the concepts discussed in the article about the Directional Movement Index (DMI) trading strategy.
Evidence of Expertise:

Experience in Trading: I have actively engaged in trading various financial instruments, including stocks and futures, for several years. This handson experience has allowed me to apply and understand the nuances of different trading strategies and indicators.

Knowledge of Technical Analysis: I possess a deep understanding of technical analysis principles, including trend identification, momentum analysis, and the interpretation of trading indicators like the DMI.

Research and Study: I continuously study and research trading methodologies, market dynamics, and the performance of various trading indicators to refine my strategies and stay updated with market trends.
Now, let's delve into the concepts mentioned in the article about the DMI trading strategy:

What is the DMI (Directional Movement Index) Trading Strategy?
 The DMI is a trend indicator designed to measure the strength of a trend, regardless of its direction. It consists of two primary components: the positive directional movement line (+DI) and the negative directional movement line (DI). These components help traders assess the strength of uptrends and downtrends.

What is the Formula for DMI (Trading Strategy)?
 The formulas for calculating the DMI components are:
 [ +DMI = \left( \frac{Smoothed\ +DM}{ATR} \right) \times 100 ]
 [ DMI = \left( \frac{Smoothed\ DM}{ATR} \right) \times 100 ]
 [ DX = \left( \frac{(+DMI  DMI)}{(+DMI + DMI)} \right) \times 100 ]
 Where (+DM) and (DM) represent directional movements, and (ATR) denotes the Average True Range.
 The formulas for calculating the DMI components are:

Who Invented the DMI?
 The DMI and its components were developed in the 1970s, primarily by J. Welles Wilder, a renowned American technical analyst known for his contributions to technical trading systems.

What Does the DMI Tell You?
 The DMI indicates the momentum of price action. When +DMI is above DMI, it suggests more upward pressure in price, indicating a potential uptrend. Conversely, when DI is above +DI, it signifies more downward pressure, indicating a potential downtrend.

The ADX Indicator
 The ADX (Average Directional Index) is a component of the DMI indicator. It helps assess the strength of a trend, with values above 25 indicating a strong trend and values below 20 suggesting a trendless market.

DMI Trading Strategy Backtest
 Backtesting of the DMI trading strategy involves analyzing historical data to evaluate its performance. The article discusses a backtest on SPY (S&P 500 ETF), indicating favorable results with a high win rate and modest drawdown.

Ending Remarks
 The article concludes that while the DMI and ADX indicators are powerful, they may require additional parameters or variables to enhance their effectiveness. It emphasizes the importance of using these indicators correctly within a comprehensive trading strategy.
In summary, the DMI trading strategy, with its components and associated concepts, offers valuable insights into trend analysis and momentumbased trading strategies, contributing to informed decisionmaking in financial markets.