Negative Directional Indicator (-DI)

The Negative Directional Indicator (-DI) is a component of the Directional Movement Index (DMI), developed by J. Welles Wilder. The -DI line is used in technical analysis to help traders identify the strength and direction of a market trend. It specifically measures movements to the downside, helping to determine bearish pressure in the market. By comparing +DI (Positive Directional Indicator) with -DI, traders can gain insights into the momentum and make informed trading decisions. To fully understand -DI and its applications, we need to explore its calculation, usage, interpretation, and limitations.

Calculation of Negative Directional Indicator (-DI)

The -DI calculation involves several steps, starting with the determination of daily price movements and then applying Wilder’s smoothing techniques. Here’s a breakdown of the process:

  1. Calculate True Range (TR): True Range is the greatest of the following:
    • Current High - Current Low
    • Absolute Value of the Current High - Previous Close
    • Absolute Value of the Current Low - Previous Close
  2. Calculate Negative Directional Movement (-DM): If the previous low minus the current low is greater than the current high minus the previous high, and greater than zero:
    • Negative Directional Movement (-DM) = Previous Low - Current Low Otherwise:
    • Negative Directional Movement (-DM) = 0
  3. Smooth -DM and TR: Apply Wilder’s smoothing method, which is akin to a moving average but with certain adjustments. The commonly used period is 14.
    • Smoothed -DM = Previous -DM - (Previous -DM/Period) + Current -DM
    • Smoothed TR = Previous TR - (Previous TR/Period) + Current TR
  4. Calculate the -DI: -DI is calculated as:
    • -DI = (Smoothed -DM / Smoothed TR) * 100

The final value is plotted on an oscillator that traders can use to analyze market conditions.

Usage of -DI in Trading

The -DI line is predominantly used in conjunction with the Positive Directional Indicator (+DI) to form the DMI that represents the overall directional movement in the marketplace. Here are some common uses:

  1. Identifying Trend Direction:
    • When -DI is above +DI, it indicates that the market trend is predominantly bearish.
    • Conversely, when +DI is above -DI, it suggests a bullish trend.
  2. Generating Trade Signals:
    • A common trading strategy is the crossover method. If +DI crosses above -DI, it can be considered a buy signal. If -DI crosses above +DI, it can be interpreted as a sell signal.
  3. Assessing Trend Strength:
    • The distance between +DI and -DI can indicate the strength of a trend. A wider gap suggests stronger trends, while a narrower gap suggests weaker trends.

Interpretation and Analysis

Understanding how to interpret the -DI in various market conditions is crucial:

  1. Bullish and Bearish Crossovers:
    • A bullish crossover occurs when +DI crosses above -DI, signaling upward momentum.
    • A bearish crossover happens when -DI crosses above +DI, indicating downward momentum.
  2. Wilder’s ADX:
    • The Average Directional Index (ADX), another component of Wilder’s DMI system, is often used in conjunction with +DI and -DI. ADX measures the strength of a trend without considering its direction.
  3. Divergences:
    • Comparing price movements against -DI can help spot divergences. If prices are rising while -DI shows increasing values, it may be a sign of underlying weakness.

Example of -DI Application

Let’s consider an example to demonstrate how -DI can be applied in a real trading scenario:

  1. Stock XYZ Analysis:
    • Calculate the True Range (TR) for each day.
    • Determine Negative Directional Movement (-DM) using price lows.
    • Smooth the values of -DM and TR over a 14-day period.
    • Compute -DI using the smoothed values.
    • Plot -DI and +DI on the chart.
  2. Trading Signals:
    • If -DI crosses above +DI, XYZ shows bearish momentum, leading to a possible short position.
    • If +DI crosses above -DI, bullish momentum takes over, suggesting a possible long position.

Limitations of the -DI

  1. Lagging Indicator:
    • Like most trend-following indicators, -DI tends to lag, meaning it may not capture the very beginning or end of a trend. This could result in delayed entry or exit points.
  2. Sideways Markets:
    • In ranging or sideways markets, -DI crossover signals may generate whipsaws, leading to false signals and potential losses.
  3. Dependency on Period Settings:
    • The choice of period for smoothing can significantly impact the indicator’s sensitivity. Longer periods may overlook short-term movements, while shorter periods could result in excessive noise.

Enhancing -DI with Other Indicators

To mitigate some of the limitations, traders often use -DI in combination with other technical analysis tools:

  1. Combining with ADX:
    • Using ADX alongside -DI and +DI helps to filter out weak trends, ensuring trades are only taken in strong trending environments.
  2. Moving Averages:
    • Implementing moving averages can help smooth out price action and validate trends identified by -DI crossovers.
  3. Oscillators:

Conclusion

The Negative Directional Indicator (-DI) is a versatile tool in technical analysis, facilitating the identification of bearish trends and aiding in the generation of trade signals. When effectively combined with other indicators and proper risk management strategies, -DI can substantially augment a trader’s analytical capabilities. However, it’s essential to be aware of its limitations and continuously validate its signals with comprehensive market analysis. For those interested in a deeper dive, consider exploring specialized trading platforms and resources like the official J. Welles Wilder website for more advanced insights and educational materials.