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Dynamic Momentum Index
Description
The Dynamic Momentum Index (DMI) was developed by Tushar Chande and
Stanley Kroll. The indicator is covered in detail in their book The
New Technical Trader.
The DMI is identical to Welles Wilder’s Relative Strength Index
except the number of periods is variable rather than fixed. The
variability of the time periods used in the DMI is controlled by the
recent volatility of prices. The more volatile the prices, the more
sensitive the DMI is to price changes. In other words, the DMI will
use more time periods during quiet markets, and less during active
markets. The maximum time periods the DMI can reach is 30 and the
minimum is 3. This calculation method is similar to the Variable
Moving Average, also developed by Tushar Chande.
The advantage of using a variable length time period when
calculating the RSI is that it overcomes the negative effects of
smoothing, which often obscure short-term moves.
The volatility index used in controlling the time periods in the DMI
is based on a calculation using a five period standard deviation and
a ten period average of the standard deviation.
Interpretation
Chande recommends using the DMI much the same as the RSI. However,
because the DMI is more sensitive to market dynamics, it often leads
the RSI into overbought / oversold territories by one or two days.
Like the RSI, look for overbought (bearish) conditions above 70 and
oversold (bullish) conditions below 30. However, before basing any
trade off of strict overbought/oversold levels using DMI or any
overbought/oversold indicator, Chande recommends that you first
qualify the trendiness of the market using indicators such as
r-squared or
CMO. If these indicators suggest a
non-trending market, then trades based on strict overbought/oversold
levels should produce the best results. If a trending market is
suggested, you can use the DMI to enter trades in the direction of
the trend.
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