The DMI indicator is a trend indicator that makes possible to assess the power of the latter and in particular to assess the balance of power between buyers and sellers.
It was invented by someone rather famous in the world of technical analysis: the American engineer J. Welles Wilder who also developed other indicators such as the Average Directional Index (ADI), the Average True Range (ATR), the Parabolic SAR or the famous Relative Strength Index (RSI).
The DMI indicator is actually composed of two indicators that are superimposed: the DMI itself, which represents the dominant consensus, and the ADX (Average Directional Index), which filters certain signals.
The DMI itself consists of two lines. The +DI represents the buying force (usually materialized in blue) while the -DI represents the selling force in presence (usually materialized in red).
The further apart the curves are from each other, the more the market is dominated by a consensus.
When the curves cross, this can lead to buy/sell signals on the prices. However, this gives many false signals, especially in periods of market equilibrium or range.
To filter the signals as well as possible (and avoid false signals, which are very numerous with this indicator), a third curve called ADX is added to the indicator. It represents the average between the +DI and -DI to which an exponential moving average is applied. It measures the relative strength of the dominant consensus. If the +DI (buying force) is above the -DI, we will consider that the sellers are in strength.
But what is their strength? Is it all relative or on the contrary very marked?
It is the ADX that shows us this: if it is high, we can consider the buying side as clearly dominating the debate. If it is low, buyers do not hold the market sufficiently, and it will be better to wait before buying.
–> The ADX does not tell us the current trend, but the strength of it.
During the crypto-currency bubble at the end of 2017, the value of Bitcoin soared. Here, the upward trend was all the stronger as the ADX (in white) was very high.
On the other hand, during periods of market indecision, +DI and -DM intersect and the ADX is relatively low.
Want to learn more? The following articles may be of interest to you