Minus Directional Indicator -DI Explained

Minus Directional Indicator (-DI) Explained

Definition: The Minus Directional Indicator (-DI) is a component of the Directional Movement Index (DMI), a technical analysis tool used by traders to measure the strength and direction of a market trend. It specifically measures the force of recent negative price movements, indicating the strength of a downtrend.

Key Takeaway: The -DI helps traders identify the strength of bearish trends, providing insights into potential selling opportunities and the momentum behind price declines.

Mechanics

The -DI is calculated using a series of steps, typically involving the Average True Range (ATR) and the Directional Movement values. Here’s a simplified breakdown:

Directional Movement: The directional movement is the difference between the current period’s low and the previous period’s low (for -DI).

1. Calculate +DM and -DM:
   • +DM (Positive Directional Movement) is the difference between the current high and the previous high, if it's greater than the previous low to current low. Otherwise, it's zero.
   • -DM (Negative Directional Movement) is the difference between the previous low and the current low, if it's greater than the previous high to current high. Otherwise, it's zero.
2. Calculate the True Range (TR): The TR is the greatest of the following:
   • The current high minus the current low.
   • The current high minus the previous close.
   • The current low minus the previous close.
3. Calculate the Smoothed +DM, -DM, and TR: These values are smoothed over a period (usually 14 periods) using a modified Wilder's smoothing method. The initial values are calculated as the sum of the first 14 periods of +DM, -DM, and TR. Subsequent values are calculated using the following formula: Smoothed Value = Previous Smoothed Value - (Previous Smoothed Value / Period) + Current Value.
4. Calculate the +DI and -DI:
   • +DI = (Smoothed +DM / Smoothed TR) * 100
   • -DI = (Smoothed -DM / Smoothed TR) * 100

The resulting -DI value is plotted on a chart, typically alongside the +DI and the Average Directional Index (ADX). The -DI value fluctuates above and below zero, and its relationship to the +DI and ADX provides valuable trading signals.

Trading Relevance

The -DI is a crucial tool for understanding bearish momentum. Here’s how traders use it:

• Identifying Downtrends: When the -DI is above the +DI, it suggests that the downtrend is stronger than the uptrend. This signals a potential selling opportunity.
• Trend Strength: An upward-sloping -DI indicates increasing selling pressure and a strengthening downtrend. A downward-sloping -DI indicates weakening selling pressure.
• Crossovers: Traders often look for crossovers between the +DI and -DI. When the -DI crosses above the +DI, it often signals the start of a downtrend (bearish signal). Conversely, when the +DI crosses above the -DI, it suggests the potential for an uptrend (bullish signal).
• Confirmation with ADX: The ADX measures the strength of the trend, regardless of its direction. Traders often use the ADX to confirm the signals generated by the +DI and -DI. A high ADX value (e.g., above 25) combined with the -DI above the +DI suggests a strong downtrend.

Example: Imagine a Bitcoin chart. If the -DI is consistently above the +DI and the ADX is rising, it indicates a strong downtrend in the Bitcoin price. This could signal that a trader might consider shorting Bitcoin or exiting long positions.

Risks

Like all technical indicators, the -DI has limitations. Here are some key risks:

• False Signals: The -DI can generate false signals, especially in choppy or sideways markets. Crossovers can occur frequently in such environments, leading to whipsaws (losing trades).
• Lagging Indicator: The -DI is a lagging indicator, meaning it's based on past price data. It may not accurately predict future price movements.
• Overbought/Oversold: The -DI doesn't directly indicate overbought or oversold conditions. Traders often need to combine it with other indicators, such as the Relative Strength Index (RSI), to identify potential reversal points.
• Subjectivity: Interpreting the -DI can be subjective. Different traders may have different interpretations of the signals, leading to varying trading decisions.
• Market Volatility: During periods of high market volatility, the -DI can generate erratic signals. It’s important to adjust trading strategies accordingly.

History/Examples

The DMI and its components, including the -DI, were developed by J. Welles Wilder Jr. in his 1978 book, New Concepts in Technical Trading Systems. Wilder also created other well-known indicators like the RSI and the ATR. His work revolutionized technical analysis and provided traders with new tools to understand market trends.

Examples in Action:

• Bitcoin’s 2018 Bear Market: During Bitcoin's significant price drop in 2018, the -DI consistently remained above the +DI, and the ADX rose to high levels. This confirmed the strength of the downtrend and provided traders with a clear signal to consider shorting the asset or avoiding long positions.
• Gold’s Downtrends: Traders in the gold market use the -DI to identify periods of strong selling pressure. A rising -DI, especially when combined with a rising ADX, can signal the beginning of a potential downtrend in gold prices, prompting traders to consider short selling opportunities or exit long positions.
• Stock Market Corrections: During stock market corrections, such as the one in early 2020 due to the COVID-19 pandemic, the -DI surged above the +DI, indicating a strong downward trend. This allowed traders to identify the selling pressure and adjust their portfolios accordingly.

In conclusion, the -DI is a valuable tool for understanding and trading in financial markets. Although it has limitations, when used in conjunction with other indicators and proper risk management, it can significantly improve a trader's ability to identify and profit from downtrends.