What Is Wilder's DMI (ADX) Indicator?

What Is Wilder's DMI (ADX) Indicator?

Let me explain Wilder's DMI (ADX) to you directly: it's a set of three indicators designed to measure both the strength and direction of a trend. The Directional Movement Index (DMI) includes the ADX line (typically black), the DI+ line (green), and the DI- line (red). The ADX specifically shows how strong the trend is—the higher its value, the stronger the trend. You can change the colors in your software, but black, green, and red are the defaults.

The DI+ and DI- lines indicate the current price direction. When DI+ is above DI-, it means the momentum is upward. Conversely, if DI- is above DI+, the momentum is downward.

Key Takeaways

Here's what you need to know: The DMI combines +DI, -DI, and ADX. The +DI and -DI track upward and downward price movements, and their crossovers can serve as signals for trades. ADX quantifies the trend's strength in either direction; a value over 25 points to a robust trend.

The Formula for Wilder's DMI (ADX)

The formulas involve calculations for +DI, -DI, DX, and ADX, typically based on 14 periods. You'd calculate directional movements and true ranges, then smooth them to derive the indicators. For a visual, imagine a chart showing these equations step by step, but I'll walk you through the process in the next section.

How to Calculate Wilder's DMI (ADX)

Calculating this indicator involves several steps, and I'll lay them out clearly for you. Start by figuring out +DM, -DM, and True Range (TR) for each period—14 periods is the standard. Use +DM when the current high minus the previous high exceeds the previous low minus the current low. Switch to -DM when the opposite is true. TR is the largest of current high minus current low, current high minus previous close, or current low minus previous close.

Next, smooth the 14-period averages for +DM, -DM, and TR. For TR, sum the first 14 readings, then for subsequent values, subtract the prior 14TR divided by 14 and add the current TR. To get +DI, divide the smoothed +DM by the smoothed TR and multiply by 100. Do the same for -DI using smoothed -DM.

For the Directional Movement Index (DX), subtract -DI from +DI, divide by their sum (using absolute values), and multiply by 100. Finally, to obtain ADX, average the DX values over 14 periods initially, then use a smoothing formula: multiply the prior ADX by 13, add the current DX, and divide by 14.

What Does Wilder's DMI (ADX) Tell You?

Developed by J. Welles Wilder in 1978, this indicator reveals the strength of a trend, whether it's upward or downward. Wilder suggested a trend exists when ADX exceeds 25, with values ranging from 0 to 100. If DI+ is above DI- and ADX is 25 or higher, you're looking at a strong uptrend. If DI- tops DI+ with the same ADX threshold, it's a strong downtrend.

Keep in mind, ADX can remain above 25 during trend reversals, indicating the new direction is just as strong. You might adjust the threshold—say, to 20 for earlier signals or 30 for more conservative ones—depending on the market.

Trading with Wilder’s DMI

You can use DMI in various ways beyond the basics. For DI crossovers, go long when DI+ crosses above DI- and place a stop-loss below the day's low or a recent swing low. Go short when DI- crosses above DI+, with a stop above the high or recent swing high. Use trailing stops to secure profits as the trade progresses. Ensure ADX is over 25 for these crossovers to confirm trend strength; below 20, consider range-bound strategies.

Watch for DI contractions and expansions too. When the lines spread apart, volatility is rising—short-term traders might enter there. When they converge, volatility drops, and swing traders could build positions expecting a breakout. Always pair this with other indicators and price action to boost your success rate.

Example of How to Use Wilder's DMI (ADX) Indicator

Take Shopify Inc. (SHOP) as an example: its chart shows periods of trends and consolidation. You'll see multiple +DI and -DI crossovers, but not all come with ADX above 25. Trigger long trades when +DI is above -DI and ADX crosses 25 (marked by up arrows). Short when -DI is above +DI and ADX hits that level (down arrows). Contractions, where lines squeeze together, often precede expansions and breakouts, offering trading chances. Remember, this indicator can produce false signals, so combine it with other analysis or filters.

Wilder's DMI vs. Aroon

Both indicators offer crossover signals, but they differ in approach. DMI smooths price fluctuations to measure up and down movements. Aroon, however, tracks the time since highs or lows within a period, focusing on different aspects.

Limitations of Using Wilder's DMI (ADX)

This indicator relies on historical data, so it might not predict future moves accurately. It lags, often signaling trend changes after they've started, which can make some signals late. An ADX of 20, 25, or 30 doesn't guarantee a trend will continue—many fizzle out. You'll encounter whipsaws, where crossovers lead to losing trades. To mitigate this, use it alongside other tools.