Getting Into The Game

When a trend has already begun, does that mean its too
late to get in? Not necessarily. This trading technique can
help you get into a trend so you dont have to miss trading
opportunities.

by Barbara Star, PhD

omputer charting software that allows traders to create their own custom studies and formulas opens the
door to a world of experimentation that could lead
to the development of a new trading indicator. But it
isnt always necessary to go to those lengths in order
to find useful trading tools. Sometimes simply combining the components of one well-known indicator

32 January 2013 Technical Analysis of Stocks & Commodities

with another is enough to create a type of synergy that can

enhance trading.
For several years, one of my templates for short-term trading has included something I call the DMI stochastic, which I
use mainly to identify potential entries into an existing trend.
The template consists of a trend-identifying oscillator based
on indicators from J. Welles Wilders directional movement
index (DMI) and also a momentum indicator derived from
that oscillator. Together, they offer two indicators that capture
three powerful technical analysis basics: trend, momentum,
and support/resistance. While not as reliable for intraday
trading, they work well in 60-minute, end-of-day (EOD),
and weekly time frames. This article shows how to create
and apply these indicators using EOD charts.

LIZ ADAMS

The DMI Stochastic

TRADING SYSTEMS

SPY, SPDR S&P 500 TRUST, D, 00:00-00:00 (Dynamic)

142.00
140.00
138.00
136.79
136.00
134.00
132.00
130.00
128.00

DMI Oscillator (14, #000000, #000000)

20.00
12.88
0.00
-20.00

Directional Movement

40.00

19.91

Figure 1: SPY with Directional Indicators. The lower panel of this chart displays the 14-period plus and minus directional indicators as they are usually plotted
in charting software. The middle panel shows a 14-period DMI oscillator in histogram form that crosses above and below a zero line.

DMI oscillator

Within the suite of indicators that make up Wilders directional

movement index (DMI) are the plus directional movement
indicator (+DI) and the minus directional movement indicator
(DI). They provide the foundation for the more widely rec
ognized average directional index (ADX). Whereas the ADX
offers information about the strength of price movement but
not its direction, the +DI and DI furnish information about
the positive or negative direction of price movement over a
period of time.
Wilder provides complete information about the function and
construction of all the components that make up the directional
movement index in his 1978 book, New Concepts In Technical
Trading Systems. In general, the plus and minus components
of the DMI focus on that portion of the current bars trading
range that is outside the range of the previous price bar. If it
is higher, it is considered to be positive (+) and if it is lower,
it is labeled negative (-). These values are divided by the true
range and averaged over time, usually 14 periods. A move by
the +DI above the DI indicates that positive or upward price
direction has overtaken negative or downward price direction.
Conversely, when +DI falls below DI, declining price either
from selling pressure or lack of upward price momentum is
taking control. Potential changes in direction or trend occur
when the lines intersect.
Charting programs display them as lines that cross and
often crisscross above and below each other as seen in
the bottom panel of Figure 1. However, I prefer to display
directional movement and the points at which the lines
cross as an oscillator. This is achieved by subtracting the
minus directional movement indicator value from the plus
directional movement value. The resulting oscillator crosses
above and below a zero line, which I then change from a

line form to a histogram as seen in the panel just below the

price chart.
Displaying the oscillator this way does not change either
the numeric values or the place where the plus and minus DI
cross; it is only a matter of visual preference. The zero line
of the oscillator represents the point at which the +DI and the
DI intersect. For me, the histogram reduces some of the noise
created by the fluctuating lines and makes it easier to avoid
false changes of price direction. It also presents a clear picture
of increasing and decreasing price momentum.

The settings

My template changes the lookback period of the plus and

minus DI from the usual default of 14 bars to 10. So for the
remainder of this article, the DMI seen on the charts will be
a 10-period +DI minus a 10-period -DI plotted in a histogram
format. To more clearly outline the high and low oscillator
changes, I plot a one-period moving average of the DMI itself
as a solid line that overlays the histogram. In the template,
the price bars are blue when the DMI is above zero and red
when it is below the zero line. (See sidebar DMI Oscillator
at our website at http://www.traders.com/Documentation/
FEEDbk_docs/2013/01/StarSB1.html.)

Charting programs display

them as lines that cross
and often crisscross above
and below each other, as
seen in the bottom panel
of Figure 1.
January 2013 Technical Analysis of

Stocks & Commodities 33

eSIGNAL TEAM

31.16

TRADING SYSTEMS

IBM, INTERNATIONAL BUSINESS MACHS, D, 00:00-00:00 (Dynamic)

212.00

208.00
204.00

200.00
196.00
192.00
188.00
183.65

A
DMI Oscillator (10, #0000ff, #ff0000)

40.00
20.00

B
0.00

chnical Analysis of STOCKS & COMMODITIES magazine

-21.32
-34.80

ren MooreFigure
with 2:approval
or changes:
IBM and the DMI Oscillator. In my template, the DMI oscillator uses a 10-bar lookback period and colors the price bars blue when the oscillator is above the19.91
zero line and red when it is below. By itself the DMI oscillator provides information about price direction, price corrections, consolidations, expansions, and divergences.

0570 fax: 206-938-1307 email: KMoore@Traders.com

Follow price direction

By itself, the DMI provides considerable information. As

#1colored bars that idenseen in the IBM chartPROOF
(Figure 2), the
tify the position of the oscillator in relation to its zero line
clearly display price direction, corrections, and transitions
to a new trend.
The DMI is sensitive to price movement. When the oscillator
is above zero but losing upward momentum, a consolidation
or pullback is usually taking place. And if price continues its
upward climb but the oscillator makes lower highs, look for
a bearish divergence. Or if the oscillator is below zero and
moving up but price continues its decline, then look for a
bullish divergence.

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34 January 2013 Technical Analysis of Stocks & Commodities

Divergences warn of a potential reversal. In the chart, an

A identifies the places where a bullish and a bearish divergence took place.
The area around the zero line often acts as support or
resistance. Trend continuations occur when the oscillator
moves to the zero line (or penetrates it briefly) and rebounds
from it to continue in the direction of the original trend. This
was the case at B in early July during a price decline. The
oscillator moved up to the zero line where it met resistance
and then rolled over as price continued its downward spiral.
The reversal from the zero line was easy to recognize because
price bars turned from blue to red.
The area in the vicinity of the zero line also helps identify
price consolidations, which exhibit sideways or rangebound
behavior in quiet markets. C on the left side of the chart
is a good example. Very often during sideways price action,
the DMI oscillator remains within the +10 and -10 zone on
its histogram.

Add the DMI stochastic

The DMI stochastic uses the basic formulation for a 10, 3, 3 stochastic oscillator found
in most charting packages but replaces
the closing price of the price bar with the
value of the 10-period DMI oscillator.
The overbought and oversold levels are
different also. They occur at the 10 and 90
levels instead of the more usual 20 and 80
levels. The DMI stochastic is much faster
and less smooth than a stochastic based
on price. However, it reaches extremes
quickly, which allows for timely entries
and exits.

IBM, INTERNATIONAL BUSINESS MACHS, D, 00:00-00:00 (Dynamic)

212.00

208.00

3
1
DMI Oscillator (10, #0000ff, #ff0000)

204.00

10

200.00

196.00
JANUARY 2010 Technical
Analysis of STOCKS & COMMODITIES magazine
7
192.00

Please contact Karen Moore with approval or changes:

188.00
183.65

phone: (206) 938-0570 fax: 206-938-1307 email: KMoore@Traders.com24.85

40.00
20.00
0.00

PROOF #2

DMI Stochastic Extreme (10, 3, 3, #009500, 10, #ff0000, 90, true)

-21.32
100.00
87.69
50.00
25.00

Learn How To
FIGURE 3: DMI Oscillator and DMI Stochastic. The DMI stochastic is based on the values of the DMI oscillator. Arrows point to reversals from oversold and
Generate
overbought at the locations where extremes have been reached and are changing direction. Short horizontal lines were
placed above and belowA
price levels that correspond
with the DMI stochastic to show how the extremes also help identify support and resistance levels.

Figure 3 shows the DMI stochastic in the panel below the

DMI oscillator. Arrows point to the reversals from oversold
and overbought levels at the locations where extremes have
been reached and are changing direction.
Even though the primary function of the DMI stochastic
is to register changes in momentum, the extremes help
spot price support and resistance areas. These enable the
trader to see breakouts and even changes in trend. (See
sidebar DMI Stochastic Extreme at our website at http://
www.traders.com/Documentation/FEEDbk_docs/2013/01/
StarSB2.html. )
To better illustrate that point, I placed small horizontal
lines on the chart below the price levels that correspond to
oversold extremes and above the price levels at which the
DMI stochastic registered overbought extremes. These help
provide a better directional sense of the price swings as well
as areas of potential support and resistance.
One example of support occurred following the sideways
price move seen in February at point 1 when price made a
short up move (point 2), which sent the DMI stochastic to an
overbought extreme. The shallow pullback near the beginning
of March at point 3 produced a DMI stochastic decline to an
oversold level and marked an area of potential support. Price
held that support and broke out above point 2, which led to a
nice price move into the middle of March (point 4), where the
DMI stochastic once again reached overbought levels.
In another example, the transition from uptrend to downtrend occurred in May, with the break below the April price
lows. The April low on the stochastic at point 5 did provide
support for a price rally in late April that retested the old
highs (point 6). But support at point 5 was soon broken to
the downside. Subsequent price rallies at points 8, 9, and

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of points 5 and 7.

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use pullbacks to the oversold area on the DMI stochastic for
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January 2013 Technical Analysis of

Stocks & Commodities 35

TRADING SYSTEMS

AMGN, AMGEN INC, D, 00:00-00:00 (Dynamic)

DMI Oscillator (10, #0000ff, #ff0000)

DMI Stochastic Extreme (10, 3, 3, #009500, #ff0000, 90, true)

s of STOCKS & COMMODITIES magazine

FIGURE 4: Entries On Amgen. The DMI stochastic is useful for finding entries in a trending market. The green arrows on the price chart point to profitable trades in a
rising market by entering on oversold extremes when the DMI oscillator is above zero and price bars are colored blue.

roval or changes:

the oversold level as support and place initial stops below the

8-1307 email:
KMoore@Traders.com
price areas
that correspond to those support levels.

ROOF

The chart of Amgen (AMGN) in Figure 4 illustrates when

to enter and when to avoid entry using this technique as prices
are rising. An X was placed above the price bars in May
#1
to indicate that no entry should be taken because the price
bars were red at the same time the stochastic reached its low
extreme and produced an up arrow.
A slightly different scenario occurred at the X over the price
bars in June. At that time, the price bars were blue and the DMI
oscillator rose above the zero line, but the DMI stochastic had
not reached its lower extreme, so no up arrow was generated.
The first green arrow seen under the price bar occurred after a

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36 January 2013 Technical Analysis of Stocks & Commodities

pullback that briefly turned the price bars red as price formed
a small double bottom and then turned blue along with an up
arrow in the DMI stochastic. The horizontal line above price
is to remind traders that even though a potential entry has been
given, price was still in a trading range and might not be able
to push through its upper resistance level.
By using only the up arrows as entries while the DMI
oscillator was above zero and the bars were blue, traders
who may have missed the initial thrust or who wished to
add to their positions would have been able to enter profitable trades on the DMI stochastic pullbacks later in June
and again in July.
In a downtrending market like that seen in Figure 5, the DMI
oscillator is below its zero line and price bars are red. The
red arrows that appear when the DMI stochastic has reached
the upper extremes point to the potential entries. The odds
favor waiting for red bars to confirm the downward move
and for price to break support rather than initiate a trade to
the downside while the bars are blue.
Generally, during pullbacks in a strong uptrend, the price
bars remain blue despite the DMI stochastic falling from an
overbought to an oversold range. And if red bars do occur, they
usually only last for a few bars before returning to blue. During strong downtrends, price bars remain red and only briefly

Sometimes simply combining

the components of one wellknown indicator with another
is enough to create a synergy
that can enhance trading.

JBL, JABIL CIRCUIT INC, D, 00:00-00:00 (Dynamic)

28.00
26.00
24.00
22.00
20.00
18.80
18.00

DMI Oscillator (10, #0000ff, #ff0000)

20.00
1.95
-20.00
DMI Stochastic Extreme (10, 3, 3, #009500, 10, #ff0000, 90, true)

100.00
75.00
50.00
31.96
14.81
0.00

FIGURE 5: Entries in a Declining Market. Rather than try to catch a top on JBL, it is usually better to wait for a red arrow on an overbought DMI stochastic when the
DMI oscillator is below zero, the price bars are red, and price has broken below a recent support level, as depicted by the horizontal lines in March and April.

turn blue during some rallies that take the DMI stochastic to
overbought levels.

Reversal alerts

Unfortunately, not all directional changes in price take place

at the upper and lower extremes of the DMI stochastic. Some
price movements create partial changes, causing the DMI
stochastic to flip back and forth during its journey. Sometimes, the stochastic never reaches an extreme. Three such
instances can be seen on the chart of Bed, Bath and Beyond

(BBBY) during March and April 2012 in Figure 6. (See sidebar

Reversal Alerts at our website at http://www.traders.com/
Documentation/FEEDbk_docs/2013/01/StarSB3.html.)
To address that issue, I developed reversal alerts to identify
all changes in the DMI stochastic, not just those that occurred
at the extremes. The reversal alerts were created by applying
a simple moving average to the DMI stochastic. The alerts
appear as diamonds above or below price whenever the DMI
stochastic crosses a three-period moving average of itself.
However, the reversal alerts occur so frequently that they

BBBY, BED BATH & BEYOND INC, D, 00:00-00:00 (Dynamic)

DMI Stochastic Reversal Alerts (10, 3, 3, 3, #008000, #ff0000)

74.00
72.00
70.00
68.84
68.00
66.00
64.00
62.00
60.00
58.00
40.00

DMI Oscillator (10, #0000ff, #ff0000)

20.00
0.00
-4.02
-8.55
-20.00

DMI Stochastic Extreme (10, 3, 3, #009500, 10, #ff0000, 90, true)

100.00

75.00
50.00
25.00

3.57

FIGURE 6: BBBY with Reversal Alerts. The diamond reversal alerts monitor all shifts in direction by the DMI stochastic. This makes it possible to identify points
between the extremes as well as to both the extremes. Three examples are seen in this chart of BBBY.
January 2013 Technical Analysis of

Stocks & Commodities 37

HAL, HALLIBURTON CO, D, 00:00-00:00 (Dynamic)

Moving Average

60.00
55.00
50.00
45.00
40.00
40.00
34.47
32.00
30.00

DMI Oscillator (10, #0000ff, #ff0000)

20.00
0.00
-7.17
-20.00
-33.42
-40.00

DMI Stochastic Extreme (10, 3, 3, #009500, 10, #ff0000, 90, true)

80.00
40.00
2.25

FIGURE 7: Countertrend Trade. Countertrend opportunities arise when the DMI oscillator levels rise above +20 or fall below -20. The DMI stochastic arrows that follow
or point to declines or rallies may appeal to more aggressive short-term traders.

would not be profitable to use for initiating trades. Instead,

I suggest using them to warn of potential directional change
when already in a trade and for adjusting stop-loss levels.
Because the DMI stochastic reversal alerts appear with every
shift and turn, they will also occur at stochastic extremes as
well. This often offers the advantage of an early warning prior
to an actual directional change signaled by the arrows.

Countertrend opportunities

Even though the main reason for using the DMI stochastic is
to find entries in an existing trend, in some cases it also holds
an appeal for those traders who like to pick up a point or two
on countertrend moves.
Normally, the probabilities favor long trades when price bars
are blue and the DMI stochastic flashes a green arrow, and short
trades when the bars are red and a red arrow appears on the
DMI stochastic. But when values on the DMI oscillator reach
+20 or above, a short decline or sideways price action often
takes place on the blue price bars at the next red arrow on the
DMI stochastic. When the DMI oscillator reaches or exceeds
20 and the price bars are red, a short-term rally or sideways
price action frequently occurs at the next green arrow on the
stochastic.
The chart of Halliburton (HAL) in Figure 7 illustrates
countertrend opportunities. Dashed horizontal lines are placed
at the +20 and 20 levels of the DMI oscillator. The red and
green arrows on the price chart indicate the areas at which
the DMI oscillator was above +20 and below 20. The price
chart includes a 20-period simple moving average mainly to
put into better perspective the direction and amount of each
countertrend price decline or rally.
Most countertrend trades are short-lived with small profits
at best. Occasionally, though, what begins as a countertrend
trade with a reversion to the mean turns into a trend reversal.
This occurred after the second red arrow on price when blue
bars turned into red bars as the DMI oscillator fell below its
zero line.
38 January 2013 Technical Analysis of Stocks & Commodities

It is during those times that countertrend trading brings

larger profits. In general, countertrend trades are best suited
for the more advanced trader who knows how to quickly move
into and out of a trade.

Jump into the trend

Sometimes, traders miss the beginning of a trend and then

stand on the sidelines, not knowing where or when to enter
as they watch price (and profits) pass them by. As trading
tools, the DMI oscillator and DMI stochastic together offer a
rapid method for assessing price direction and identifying a
technique for jumping into an existing trend.
While the DMI stochastic is not a trading system, it can help
move traders off the sidelines and into the game.
Barbara Star is a retired university professor. She is a past vice
president of the Market Analysts of Southern California and
led a MetaStock users group for many years. Her articles and
software reviews have been published in Technical Analysis
of Stocks & Commodities since 1991. Currently, she trades
part-time and provides individual instruction and consultation
to those interested in the technical analysis of the financial
markets. Star lives in Woodland Hills, CA, and can be reached
at 818 224-4070 or by email at star4070@aol.com.

Suggested reading

Wilder, J. Welles [1978]. New Concepts In Technical Trading

Systems, Trend Research.
eSignal (charts, data, and studies)

See our Traders Tips section beginning on page 65 for commentary

and implementation of Barbara Stars technique in various technical
analysis programs. Accompanying program code can be found in
the Traders Tips area of Traders.com.
The three sidebars referred to in this article can be found at
Traders.com at the URLs noted.