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The Directional Movement Indicator (DMI) is another statistic/chart developed by J. Welles Wilder who you may remember also developed RSI and Parabolic SAR. DMI like Parabolic SAR is derived from a relatively complex formula which we won’t discuss but if you’re interested please visit this tutorial on calculating DMI. The intention of the DMI is to spot trends and trend reversals (pretty much the intention of all technical indicators) and, more specifically, to act as a filter for the Parabolic SAR. As we mentioned in the post on Parabolic SAR??????????????????????????????????????????????????????????????????????????????????????????????? can often guide you as to which signals are true and which are not.
I’ve added some blue lines for guidance in the above chart of Parabolic SAR and DMI. Basically, DMI makes signals when DM+ (the blue line) crosses upward through DM- (the red line). As you can see from the graph, both the Parabolic SAR and DMI do not make any real signals during choppy trading in June and July, but in mid-August, the DM+ line crosses well above the DM- line at the same time that the Parabolic SAR flips and signals an uptrend. Though there are some hiccups from August until December in the Parabolic SAR signals, the DMI never makes any conclusive buy points which would inform an investor in this stock that the uptrend is not yet over and it is (relatively) safe to continue to hold their position in the stock.
The DMI chart also includes one more line, the ADX line (black). This is essentially a smoothed difference of DM+ and DM-. Wilder found that his statsitics, Parabolic SAR and DMI, were much more effective during trending periods and ADX is a way of being able to tell whether a stock is truly trending. If ADX has a clear upward or downward slope, then the trend is more apparent. If ADX looks flat, then one knows that the stock price has been moving in a more horizontal direction and the DMI and Parabolic SAR are likely less accurate. Another use of the ADX line is crossovers around the 40 and 20 levels. Crossing above the 20 line usually signals the beginnings of an uptrend and crossing down through the 40 line could signal the beginnings of a downtrend.
In the chart above, we see a very interesting situation where it seems the uptrend has begun to taper. Two down days have brought the price very close to the Parabolic SAR support point, ADX has inflected and is verging on crossing through the 40 line but DMI has yet to provide a true sell signal. Eitherway, these are ominous signs for the near term performance of the stock. And, unfortunately, it happens to be a position I have - Tiffany’s. We’ll see how things go. It seems that I have run into some tough luck as an investor since starting this blog… But, if these tutorials are help my readers to become better investors then it was all worth it!
April 11th, 2008 at 2:22 am
I remember my first time on this website. My friend and I were looking for something totally new, something we haven’t read or heard about. And we found this site, and now we come ever day to read some cool information or to discuss something with other people. It’s interesting to hear different points of view!