V.6:8 (309-312): Defining directional movement Part 8 by Jim Summers, Ph.D.

Defining directional movement Part 8 by Jim Summers, Ph.D.

Given the old adage that "the trend is your friend" and that most trading systems follow trends, J. Welles Wilder's Directional Movement Index (DMI) lets you measure whether a trend is in effect and its strength. To develop DMI, we first measure the amount of daily directional movement (DM) within the true range (TR1) and record its direction (+ or -). As we found with the true range, exactness in definitions comes before programming.

Directional movement is either up or down. Up days are those trading days in which the intraday high exceeds the previous day's intraday high (Figure 1). The DM is positive and, in Figure 1, equals price C minus price A. If this had been an outside day—meaning the low also was lower than the previous day's low—then the amount by which the prior day's high was exceeded must be greater than the amount by which the prior day's low was exceeded. In other words, in Figure 1, C - A must be greater than D - B. A limit day follows the same formula as an up day. the amount of directional movement would be C - A.

The reverse of these three formulas holds true for down days, as Figure 2 illustrates.

There is no directional movement on an inside day (Figure 3), where the high is lower than the prior day's high and the low is higher than the prior day's low. An extremely rare day with no movement is an outside day in which the difference between the two days' highs exactly equals the difference between the lows. Wilder does not mention this possibility in his book on DMI, New Concepts in Technical Trading Systems, but the Lotus 1-2-3 program manages it properly.