When a trend has already begun, does that mean it’s too late to get in? Not necessarily.
This trading technique can help you get into a trend so you don’t have to miss trading opportunities.
Within the suite of indicators that make up Wilder’s directional movement index (DMI) are the plus directional movement indicator (+DI) and the minus directional movement indicator (‑DI).
Whereas the ADX offers information about the strength of price movement but not its direction, the +DI and ‑DI furnish information about the positive or negative direction of price movement over a period of time.
A move by the +DI above the ‑DI indicates that positive or upward price direction has overtaken negative or downward price direction.
Conversely, when +DI falls below ‑DI, declining price either from selling pressure or lack of upward price momentum is taking control.
Potential changes in direction or trend occur when the lines intersect.
I prefer to display directional movement and the points at which the lines cross as an Oscillator (PDI - MDI). The zero line of the oscillator represents the point at which the +DI and the ‑DI intersect.
The DMI is sensitive to price movement - Divergences warn of a potential reversal
When the oscillator is above zero but losing upward momentum, a consolidation or pullback is usually taking place.
if price continues its upward climb but the oscillator makes lower highs, look for a bearish divergence.
if the oscillator is below zero and moving up but price continues its decline, then look for a bullish divergence.
The area around the zero line often acts as support or resistance.
Trend continuations occur when the oscillator moves to the zero line (or penetrates it briefly) and rebounds from it to continue in the direction of the original trend. This was the case at “B” in early July during a price decline. The oscillator moved up to the zero line where it met resistance and then rolled over as price continued its downward spiral.
The area in the vicinity of the zero line also helps identify price consolidations, which exhibit sideways or rangebound behavior in quiet markets. “C” on the left side of the chart is a good example. Very often during sideways price action, the DMI oscillator remains within the +10 and -10 zone on its histogram.
Even though the primary function of the DMI stochastic is to register changes in momentum, the extremes help spot price support and resistance areas. These enable the trader to see breakouts and even changes in trend.
The main reason for using the DMI stochastic is to find Entries in an Existing Trend
The most efficient way to find those entry points is to trade in the direction indicated by the DMI oscillator and use the DMI stochastic to suggest points of entry.
When the DMI oscillator > 0 and the Price bars are blue, use pullbacks to the oversold area on the DMI stochastic for potential entries in anticipation of continued rising price.
Unfortunately, not all directional changes in price take place at the upper and lower extremes of the DMI stochastic
The chart of Amgen (AMGN) in Figure 4 illustrates when to enter and when to avoid entry using this technique as prices are rising.
An “X” was placed above the price bars in May to indicate that no entry should be taken because the price bars were red at the same time the stochastic reached its low extreme and produced an up arrow.
A slightly different scenario occurred at the X over the price bars in June. At that time, the price bars were blue and the DMI oscillator rose above the zero line, but the DMI stochastic had not reached its lower extreme,
By using only the up arrows as entries while the DMI oscillator was above zero and the bars were blue, traders who may have missed the initial thrust or who wished to add to their positions would have been able to enter profitable trades on the DMI stochastic pullbacks later in June and again in July
An easy to understand presentation by OptionVue Systems explaining these indicators
Click to Read "Getting Into The Game The DMI Stochastic" by Barbara Star, PhD - January 2013 • Technical Analysis of Stocks & Commodities
Barbara Star is a retired university professor. She is a past vice president of the Market Analysts of Southern California and led a MetaStock users group for many years. Her articles and software reviews have been published in Technical Analysis of Stocks & Commodities since 1991. Currently, she trades part-time and provides individual instruction and consultation to those interested in the technical analysis of the financial markets. Star lives in Woodland Hills, CA, and can be reached at 818 224-4070 or by email at firstname.lastname@example.org.