E-mini Trading: Revisiting The Directional Movement Indicator And Adx
The Directional Movement Indicator (DMI) is just one of several indicators unveiled in J. Welles Wilder's landmark 1978 book, New Concepts in Technical Trading Systems. The influence of this book cannot be underestimated, as many of the indicators introduced in the book, such as the Relative Strength Index and the Parabolic SAR are the basis for scores of present day trading systems. This book is a must-read for anyone serious about e-mini trading and trading in general.
The sheer variety of adaptations of the DMI/ADX by contemporary traders is evidence of the strength of this indicator. It is difficult to read any trading text without coming across J. Welles Wilder's influence. While I am interested in order entry (tape reading) and price action to spot potential trades, the DMI/ADX is second to none as a filtering mechanism to weed out lower probability trade setups. In my opinion though, the DMI/ADX is far too sensitive to function as a primary e-mini trade indicator, it is second to none in confirming/excluding potential trades. In short, when used as a filtering indicator it is extremely valuable.
Of course, the ADX is the most popular and well-known component of this indicator; mainly for its usefulness in spotting trends and measuring trend strength. It is not unusual to see the ADX used as a stand-alone indicator; but J. Welles Wilder did not design this indicator as a standalone, he included a crossing set of lines called the DMI+ and DMI -.
Most e-mini traders consider moving averages to be effective for trade initiation in trending markets, and utilize oscillators in trading markets. (Range bound markets or continuation channels) The ADX, then, is useful in identifying trends and giving the e-mini trader and indication of the strength of the trend. The DMI + and the DMI - are essentially moving averages albeit sophisticated moving averages. In short, you can see that the combination of all of the components of the Directional Movement Indicator can deliver a total package. The ADX component of the indicator functions as an oscillator and the DMI + and DMI - are moving averages, or the component that indicates trade entry points and exit points.
But there is a problem here, as moving averages tend to lag the market by a significant margin. Trading a lagging indicator, obviously, will deliver entries that are late, and hence mis-timed. If there is a weakness in the package, it lies in the lagging nature of the moving averages, the DMI + and DMI -. For me, lagging indicators are a deal breaker. I consider entries among the most important facet of e-mini trading. When you find yourself constantly entering trades late, you miss out on a significant portion of the move or get into the trade just in time for the price action to begin a retracement.
That being said, it is easy to understand why I depend upon order entry and price action to identify trades and the DMI + and DMI - excellent moving average is to confirm trade entry. It is gratifying to have entered a trade and get confirmation of your trading decisions by observing these two lines cross. It's a confidence builder, and an integral part of a successful trade. When I enter a trade and do not get a confirming cross over I am anxious to exit the trade because it lacks confirmation.
In summary, we have begun a discussion about the Directional Movement Indicator. I have identified the components of this indicator and tried to point out the strengths and weaknesses in inherent in the DMI. Many traders dismiss lagging indicators outright, but this indicator has an important spot on your trading chart if used correctly. In further articles, we will discuss practical usage of these indicators and some of the indicator numerical levels.
The sheer variety of adaptations of the DMI/ADX by contemporary traders is evidence of the strength of this indicator. It is difficult to read any trading text without coming across J. Welles Wilder's influence. While I am interested in order entry (tape reading) and price action to spot potential trades, the DMI/ADX is second to none as a filtering mechanism to weed out lower probability trade setups. In my opinion though, the DMI/ADX is far too sensitive to function as a primary e-mini trade indicator, it is second to none in confirming/excluding potential trades. In short, when used as a filtering indicator it is extremely valuable.
Of course, the ADX is the most popular and well-known component of this indicator; mainly for its usefulness in spotting trends and measuring trend strength. It is not unusual to see the ADX used as a stand-alone indicator; but J. Welles Wilder did not design this indicator as a standalone, he included a crossing set of lines called the DMI+ and DMI -.
Most e-mini traders consider moving averages to be effective for trade initiation in trending markets, and utilize oscillators in trading markets. (Range bound markets or continuation channels) The ADX, then, is useful in identifying trends and giving the e-mini trader and indication of the strength of the trend. The DMI + and the DMI - are essentially moving averages albeit sophisticated moving averages. In short, you can see that the combination of all of the components of the Directional Movement Indicator can deliver a total package. The ADX component of the indicator functions as an oscillator and the DMI + and DMI - are moving averages, or the component that indicates trade entry points and exit points.
But there is a problem here, as moving averages tend to lag the market by a significant margin. Trading a lagging indicator, obviously, will deliver entries that are late, and hence mis-timed. If there is a weakness in the package, it lies in the lagging nature of the moving averages, the DMI + and DMI -. For me, lagging indicators are a deal breaker. I consider entries among the most important facet of e-mini trading. When you find yourself constantly entering trades late, you miss out on a significant portion of the move or get into the trade just in time for the price action to begin a retracement.
That being said, it is easy to understand why I depend upon order entry and price action to identify trades and the DMI + and DMI - excellent moving average is to confirm trade entry. It is gratifying to have entered a trade and get confirmation of your trading decisions by observing these two lines cross. It's a confidence builder, and an integral part of a successful trade. When I enter a trade and do not get a confirming cross over I am anxious to exit the trade because it lacks confirmation.
In summary, we have begun a discussion about the Directional Movement Indicator. I have identified the components of this indicator and tried to point out the strengths and weaknesses in inherent in the DMI. Many traders dismiss lagging indicators outright, but this indicator has an important spot on your trading chart if used correctly. In further articles, we will discuss practical usage of these indicators and some of the indicator numerical levels.
