Jeff Kohler the Option Addict | Stock and Options Trading

Now that I have finished my live class, the MarketCast, etc... let's get back to business. The first response I had to my post was a suggestion to talk about the DMI. Thanks for the suggestion Michael. Does anyone out there use the DMI?

Me neither.

However, it is one of many technical indicators, so we will define what it is and what it does. It has been a long time since I have discussed/studies this indicator, so excuse me for being rusty.

Encyclopedia Kohler says...

DMI

Welles Wilder, one of the greatest contributors to the field of technical analysis created the DMI, which stands for the Directional Movement Index. As many might state this indicator gives the trader the idea of whether or not the particular issue is trending or not trending. Here is a glimpse of what the study looks like.

Isn't it pretty? Does it look confusing? Do not be intimidated. Once you know what is going on here, it becomes easier to digest. Typically a DMI is calculated using two lines, but as you can see the interactive chart offers three lines...

The ADX (Average Directional Index)

+DI (Positive Directional Indicator)

-DI (Negative Directional Indicator)

The ADX is simply a moving average of the DMI, so your many use it as opposed to the DMI. For those that use the DMI, they are giving more credence to the +DI and -DI lines. Like I mentioned, the +DI is measuring positive movement, and -DI measures negative movement. In a situation like you see in my graphic, where the positive crossed the negative last month, this indicates a buy signal and when negative crosses over the positive this creates a sell signal. By the way this indicator is used on a scale of 0-100. When you take these buy and sell signals in conjunction with the ADX, as the ADX is heading higher this means the market is in an uptrend mode and this amplifies the buy and sell signals. If the ADX is low or flat, this means the buy signals would be dampened because the market is not trending.

When I first studied the DMI I found the premise to be fascinating. Since stocks are considered to trend only about 30% of the time, and 70% they are non-trending, most system traders need to know when to switch from a trending system to an oscillating system. For example, years ago when I thought system trading was "IT" I traded a moving average crossover system. Works great when things trend and is annoying as hell when things do not trend. Had I been applying a DMI back then I might have seen signals that trends might possibly cease and eliminate trading through the sideways times.

There are too many indicators out there to name, but they all try to do the same thing. They try to calculate price movements. As I have realized this over the last years, I have started to try and accomplish the same thing. Try to study price movements.

I hope this was helpful. Like I said, I had 20 minutes to put this together. As always Wednesdays are tough for me, but I hope I have kept you entertained. Tomorrow is Thursday "Blog" Day and I have lots of things we can do. See you then.

Posted by Option Addict on 11/15/2006 at 1:18 PM | Permalink