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Directional
Movement
Description
The
Directional Movement System, developed by J.
Welles Wilder, is explained thoroughly in his
book, New Concepts in Technical Trading Systems.
MetaStock
Pro calculates and plots all five of the
indicators that comprise the Directional Movement
System (i.e., CSI, +DI, -DI, ADX, and ADXR).
MetaStock
Pro also calculates a related indicator,
the Commodity
Selection Index.
Wilder's
book gives complete step-by-step instructions (and
examples) on calculating and interpreting each of the
above indicators.
Interpretation
The
basic Directional Movement trading system involves
plotting the 14-period +DI and the 14-period -DI
on top of each other in the same inner window.
An improved method of displaying these two
indicators is to plot their difference using the
following formula:
pdi(14)
- mdi(14)
Positions
should be taken by buying when the +DI rises above
the -DI (i.e., the formula shown above rises above
zero) and selling when the +DI falls below the -DI
(i.e., the formula falls below zero).
These
simple trading rules are qualified with the
"extreme point rule."
This rule is designed to prevent whipsaws
and reduce the number of trades.
The
extreme point rule requires that on the day that
the +DI and -DI cross, you note the "extreme
price." If
you are long, the extreme price is the low price
on the day the lines cross.
If you are short, the extreme price is the
high price on the day the lines cross.
The
extreme point is then used as a trigger point at
which you should implement the trade.
For example, after receiving a buy signal
(the +DI rose above the -DI), you should then wait
until the security's price rises above the extreme
point (the high price on the day that the +DI and
-DI lines crossed) before buying. If the price
fails to rise above the extreme point, you should
continue to hold your short position.
In
Wilder's book, he notes that this system works best on
securities that have a high Commodity
Selection Index (CSI) value.
He says, "as a rule of thumb, the
system will be profitable on commodities that have an
ADXR value above 25.
When the ADXR drops below 20, then do not
use a trend-following system." |
