Full Review of the Directional Movement Indicator for Binary Options Trading
The Directional Movement Index is an indicator and trading tool developed by J. Wells Wilder. First introduced in his book “New Concepts In Technical Trading” it has come to widespread use. Find out if this indicator can be applied to binary options.
What Is The Directional Movement Index
The Directional Movement Index is a tool developed by J. Wells Wilder. He introduced it in his book “New Concepts In Technical Trading” (1978). It is an indicator with a different approach than most others. This indicator seeks to identify points of market equilibrium versus other indicators that seek to measure market extremes. The Directional Movement Index, or DMI (also DX on some platforms) is made up of two parts; the positive directional index and the negative directional index. Sometimes, as with my examples here, it is also displayed with the Average Directional Index for added analysis. Basically, positive DI measures the upward movements in an asset while the negative DI measures the downward movement. The index is calculated using price data and compares today’s price with yesterday’s price. Movements are displayed on an upward and downward line that range from 0-100. The lines not only show direction but also strength of the movement. The two calculations are then used to create the ADX which helps to determine underlying trend.
How The Directional Index Works
The Directional Index works best as a trend following indicator. It works well in both directions, up and down, and in multiple time frames. The basic signal is when, in an uptrend, positive DI dips below the negative DI line and then crosses back over. The same is true in reverse for a down trend. When the negative DI moves above the positive DI line and then crosses back below it generates a put signal. This signal is enhanced when it can be traced from one time frame to another. For example, you identify a call buying signal on the daily chart and then moved down to the hourly chart and buy in at the next bullish signal it delivers.
Wilder advises in his books not to use the DMI on its own but as a convergent indicator. The DMI, can deliver a large number of whipsaws on its own, especially when used for trading counter to the trend. Mr. Wilder suggests that ADX be added, which is why it is often displayed along with the DMI. Typically, when the +DI line is above the -DI line the market is trending up. When the -DI line is above the +DI it is trending down. The addition of the ADX helps to eliminate whipsaws because it measure the strenght of the market. When it is above 30 the market is trending and when it is below 30 it is range bound.
Why The Directional Movement Index Does Not Suck
This indicator does not suck because it is a trend following signal. Trend following techniques are the best, in my opinion. It also does not suck because it is a price action based indicator. Price action is the meat and potatoes of technical analysis; all trading decisions eventually come down to the price action. This indicator is also good with any asset and with multiple time frames. The best signals occur when more signals converge in more than one time period.
Why The Directional Movement Index Might Suck
This indicator might suck because it appears to be a lagging indicator. The literature I have read all agree that the basic signal is when one line crosses over another. From what I can tell this signal is valid but comes long after the ideal entry has passed. It also requires other indicators to confirm signals. Most indicators, all of them really, need confirmation but this one requires more than usual.
My Last Words On The Directional Movement Index
The DMI is a useful tool but one that definitely needs help. The index provides good trend following signals and possible some others but without the addition of other analysis also produces many whipsaws. The simple addition of the ADX to the indicator is one of many ways to help weed out bad signals. I am intrigued by this indicator and will be giving it some more attention. At this time recommended for intermediate to advanced traders only. Signals are valid but since they require other confirmation may not be the best choice for newbies.
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