Identify-The-Start-Of-A-Trend-With-DMI

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Dec 6, 2023

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Identify The Start Of A Trend With DMI Improve on certain directional movement index signals such as identifying the start of a trending move and picking market tops and bottoms. by BC Low, CMT Directional movement index (DMI) is a long-accepted and popular technical indicator created by J. Welles Wilder to establish the existence of a trend in a market using three lines — ADX, +DI, and - DI. This article shows that the same three lines can be used to significantly improve on certain DMI signals to identify the start of a trending move and to pick market tops and bottoms. The new variations in this article feature clusters of three ADX lines, three +DI lines, and three - DI lines instead of the original three lines. Directional movement index ADX signal: Average directional movement index (ADX) signals a trending market when the ADX (14 periods) is above level 20 and rising. But ADX itself does not indicate whether the market is trending up or down. That signal is provided by +DI and - DI. After ADX has risen to the 50 level and turns down, its decline represents a retracement. If there was an uptrend previously, then the declining ADX signals a correction down. If there was a downtrend previously, then the declining ADX signals a correction up. When ADX declines to below 20 again, the market is non-trending until it rises above 20. Then the market trends again. +DI & - DI Signals: The +DI and - DI indicates whether a market is trending up or down. When the ADX is rising above 20 and if +DI is positioned above ADX and rising, then the market is trending up. If ADX is rising above 20, and - DI is positioned above ADX and also rising, then the market is trending down. Basically, when price rises, +DI will rise but - DI will fall. When price falls, - DI will rise, and +DI will fall. In other words, +DI and -DI are mirror images of each other. In a strongly trending market, because the two DI lines mirror each other, the DI lines will move in opposite directions, thus opening up a sizable distance between them. In a congesting market, however, as price does not move strongly in either direction, the DI lines do not move away from each other; in fact, they tend to end up crossing each other. TAC-DMI clusters Although Wilder created the DMI and is due all credit for it, I added the acronym “TAC” to the name of this new technical tool to reflect the following modifications I incorporated into it: * The TAC-DMI clusters feature three clusters consisting of three ADX lines, three +DI lines, and three - DI lines each plotted separately. * The triple ADX cluster (3x ADX) gives the timing that signals the start of a strong trending move before it actually begins, and also the end of a trending move. * Together with the triple ADX cluster, the triple +DI cluster (3x +DI) can provide the timing signal for an intermediate or major bottom of a trending move.
* Together with the triple ADX cluster, the triple - DI cluster (3x - DI) can provide the timing signal for an intermediate or major top of a trending move. 3x ADX cluster The structure of 3x ADX: The three ADX lines are based on three, four, and five periods so as to have greater sensitivity in the indicator. (Original formulation used 14 periods.) The basic Y-axis reference levels are 30 and 70, while the critical Y-axis reference levels are 20 and 90. Signal 1: Start of a trend when 3x ADX cluster converges below 30 As a market congests, the 3x ADX cluster drifts down below level 30. Once below 30, the signals to watch for are: * All 3x ADX lines converging at one point * The 3x ADX lines turning up after converging at one point. The 3x ADX cluster turning up from <30 after converging at one point represents a good signal for the start of a new trending move. If the 3x ADX cluster falls to <20 and turns up from <20 after converging at one point, it signals the start of an even stronger trending move. Note that when a trending move starts in any of these situations, the market is not at a low or high point; it is normally at an intermediate level. There can be situations when the 3x ADX cluster turns up either below 20 or 30 level, but without first converging at one point. These situations tend not to result in good trending moves. Signal 2: End of a move when 3x ADX cluster turns down above 70 When the market is trending, the 3x ADX cluster is above 20 and rising. After the price has made a sizable move, the smallest ADX line (three-period) will rise above level 70. When the ADX cluster peaks and turns down above 70, the signal is for a retracement of the previous trending move, or even the end of the move. If the market is in an exceptionally strong trend, the 3x ADX cluster may resume up after dipping below 70. This can lead to yet another 3x ADX peak before it turns down again. Also in an exceptionally strong trend, the 3x ADX cluster will reach 90, which is a strong signal for a turn of the previous trend. 3x +DI and 3x - DI clusters The structure of 3x +DI and 3x - DI clusters: Both +DI and - DI lines are based on five, eight, and 14 periods. Five and eight are Fibonacci numbers, while 14 is the original DMI parameter used. The basic reference levels are 10 and 50, while the critical reference level is 5. 3x +Di cluster Signal 3: Signalling market bottom with +DI at Level 5 In a downtrend, the 3x +DI cluster declines. When the cluster reaches the basic reference level of 10, it is a signal that a market bottom may be reached soon. When the smallest of the 3x +DI cluster lines reaches level 5, it is a signal that a reversal up is imminent. This reversal is confirmed when the 3x +DI cluster actually turns up from level 5.
Signal 3: Signalling market bottom by combining 3x +DI cluster with 3x ADX cluster The 3x +DI bottom signal described here is doubly confirmed when it is combined with the topping off of the 3x ADX cluster. When a strong trend has brought the 3x ADX cluster to 90, watch for the 3x +DI cluster bottoming at level 5. When both clusters turn at the same time — that is, the 3x ADX cluster turns down from 90 — and the 3x +DI cluster turns up from level 5, it is double confirmation that a market bottom is formed, and a strong buy signal is in place. 3x - Di cluster Signal 4: Signalling market top with -DI at level 5 In an uptrend, the 3x - DI cluster falls. When the cluster reaches the basic reference level of 10, it is a signal that a market top may be reached soon. When the smallest of the 3X - DI cluster lines reaches level 5, it is a signal that a reversal down is imminent. This reversal is confirmed when the 3x - DI cluster actually turns up from level 5. Signal 4: Signaling market top by combining -3x ADX cluster with 3x ADX cluster The 3x - DI bottom signal described is doubly confirmed when it is combined with the topping off of the 3x ADX cluster. When the 3x ADX cluster peaks at 90 and turns down, watch for the 3x - DI cluster bottoming at level 5. When both clusters turn at the same time — that is, the 3x ADX cluster turns down from 90 — and the 3x - DI cluster turns up from level 5, it is double confirmation that a market top is formed, and a strong sell signal is in place. Conclusion These signals are applicable in all time frames: daily, weekly, and beyond. But in the weekly and larger time frames, the impact of the signals is far greater. The expanded structure of the three-line clusters makes the turning points of all three clusters much clearer. In the case of the ADX cluster, it is only with the cluster that we can differentiate the single- pointed turn from the “looser” turn. And with this difference, a new signal is created. The combination of the +DI and - DI clusters with the ADX clusters also reduces the risk when you rely on only one set of indicators. These new applications of DMI should help traders achieve a more accurate reading of the markets and better trading results. BC Low has been a teacher and practitioner of technical analysis since 1990. He was previously a technical analyst at Merrill Lynch International Bank in Singapore and a senior lecturer in Singapore Polytechnic, where he pioneered the teaching of technical analysis. He is currently the president of the Singapore Technical Analysts & Traders Society, and president of Technical Analysis Consultancy.
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