The Negative Directional Indicator (-DI) is a technical analysis tool used to gauge the downward price movement of an asset. It forms an integral part of the Average Directional Index (ADX) system, which is employed in identifying the strength and direction of a trend.
The Functionality of -DI
Calculation of -DI
The calculation of -DI involves several steps:
- True Range (TR): \( \text{TR} = \max(\text{Current high} - \text{Current low}, |\text{Current high} - \text{Previous close}|, |\text{Current low} - \text{Previous close}|) \)
- Negative Directional Movement (-DM): If the current low minus the previous low is greater than the previous high minus the current high, and greater than zero, then \(-\text{DM} = \text{Current low} - \text{Previous low}\); otherwise, \(-\text{DM} = 0\).
- -DI Calculation: The -DI is calculated using the following formula:
$$ -DI = \left( \frac{\text{SMA}(-DM, n)}{\text{SMA}(TR, n)} \right) \times 100 $$where SMA represents the Simple Moving Average, and \(n\) is the smoothing period (commonly set to 14).
Interpretation of -DI
When the -DI value increases, it indicates a stronger downward price movement. Traders use -DI values in conjunction with the Positive Directional Indicator (+DI) and the ADX to make well-informed trading decisions.
Application in Trading Strategies
Using -DI with ADX and +DI
By comparing the -DI and +DI values, traders can determine the prevailing trend direction:
- Bearish Trend: When -DI is above +DI, it signifies a bearish trend.
- Bullish Trend: When +DI is above -DI, it indicates a bullish trend. Additionally, the ADX is used to assess the strength of these trends.
Example Scenario
In a trading scenario where -DI crosses above +DI, a trader might consider entering a short position, anticipating further downward movement. Conversely, when +DI moves above -DI, it might signal the end of the downtrend and trigger a stop-loss for short positions or the opening of long positions.
Historical Context of the -DI
The Negative Directional Indicator was developed by J. Welles Wilder Jr., a pioneer in technical analysis, as part of his Directional Movement Index (DMI) system. Introduced in his 1978 book “New Concepts in Technical Trading Systems,” this system has become a cornerstone among traders and analysts for trend identification.
Applicability in Diverse Markets
The -DI, along with the ADX, is versatile and can be applied to various financial instruments, including stocks, commodities, currencies, and indices. It is particularly effective in trending markets where identifying the direction and strength of the trend is crucial for making informed trading decisions.
Comparing Related Terms
- Average Directional Index (ADX): Measures the strength of a trend, regardless of direction.
- Positive Directional Indicator (+DI): Measures the upward price movement.
- Directional Movement Index (DMI): Comprises the +DI, -DI, and ADX to form a comprehensive trading strategy.
FAQs
What is the primary purpose of the -DI?
How does the -DI work with the ADX?
Can the -DI be used alone for trading decisions?
Summary
The Negative Directional Indicator (-DI) plays a critical role in technical analysis by measuring the extent of downward price movements within the ADX system. Through its calculation, interpretation, and application, traders can leverage the -DI to identify and confirm bearish trends, making it an indispensable tool in market analysis and trading strategies.
References
- Wilder, J. W. (1978). “New Concepts in Technical Trading Systems”. Trend Research.
- Murphy, J. J. (1999). “Technical Analysis of the Financial Markets”. New York Institute of Finance.
- Investopedia. “Average Directional Index (ADX)”.
