Dynamic Momentum Index

What Is Dynamic Momentum Index?

The dynamic momentum index is a technical indicator used to decide whether an asset is overbought or oversold. It very well may be utilized to produce trade signals in trending and ranging markets. In this article, the dynamic momentum index will sporadically be alluded to as DMI for brevity, however ought not be mistaken for the directional movement index (DMI).

Understanding Dynamic Momentum Index

The dynamic momentum index was developed by Tushar Chande and Stanley Kroll and is like the relative strength index (RSI). The fundamental difference between the two is that the RSI utilizes a fixed number of time spans (generally 14) in its calculation, while the dynamic momentum index involves different time spans as volatility changes, normally somewhere in the range of five and 30.

The number of time spans utilized in the dynamic momentum index diminishes as volatility in the underlying security increments, making this indicator more receptive to changing prices than the RSI. This is especially helpful when an asset's price moves rapidly as it approaches key support or resistance levels. Since the indicator is more sensitive, traders might possibly find prior entry and exit points than with the RSI, yet it could likewise be more inclined to whipsaws and false signals.

Traders, particularly those elaborate basically in the equity markets, can is DMI to decide when a retracement is approaching its determination in either a trending or rangebound market.

• During a going market, traders watch for the indicator to fall below 30, and move back above it, to trigger a long trade. They would then sell, when the indicator moves over 70 or approaches the highest point of the reach. They could then short sell when the indicator crosses back below 70 accepting the reach is as yet flawless.
• During an uptrend, traders can look for the indicator to fall below 30 and rise back above to trigger a long trade.
• During a downtrend, watch for the indicator to rise over 70 and afterward fall below it to trigger a short trade.

Another indicator that is like the DMA is the stochastics oscillator. Both these indicators measure momentum, however they are doing it in various ways and will in this way produce various values and trade signals. The DMI consequently changes the number of periods utilized in its calculation in light of volatility. The stochastic oscillator doesn't do this. It has a fixed lookback period. The stochastic oscillator likewise has a signal line, which produces extra types of trade signals. A signal line could be added to the dynamic momentum index too.

Dynamic Momentum Index Calculation

The formula for dynamic momentum index is:
$\begin &\text=RSI=100-\frac{100}{1+RS}\ &\text RS \text\ &\text{(typically } 14)\textDMI\ &\textDMI:\ &Std_A=MA_{10} \textStd_\ &V_i=\frac{Std_}\ &T_D=INT\frac{14}\ &T_D \textRS \text\ &T_D$_{Max=30~~T_D}Min=5\ &\textbf\ &Std = \text\ &MA_10 = \text{10-Period simple moving average}\ &Std_ = \text\ &T_D_{Max = \text{Use 30 if TD is greater than 30}\ &T_D}Min = \text{Use 5 if TD is less than 5}\ &RS = \text \end
Traders decipher the dynamic momentum index in a similar way as the RSI. Readings below 30 are considered oversold, and levels more than 70 are considered overbought. The indicator oscillates somewhere in the range of 0 and 100.

30 and 70 are general levels and can be altered by the trader. For instance, a trader might opt to utilize 20 and 80 all things being equal.

As should be visible in its formula, the DMI utilizes the RSI formula, yet consolidates a differing think back period, somewhere in the range of 5 and 30 for every calculation of RS, though the RSI commonly is fixed to 14. To find the lookback period required for every calculation of RS while computing DMI, utilize the following steps:

1. Calculate the standard deviation of the last five closing prices.
2. Take a 10-period moving average of the standard deviation calculated in step 1. This is StdA.
3. Divide step one by step two to get Vi.
4. Calculate TD by dividing 14 by Vi. Just use whole numbers for the outcome, as these are meant to address time spans and in this way can't be fractions or decimals.
5. TD is limited to somewhere in the range of 5 and 30. In the event that more than 30, utilize 30. On the off chance that under 5, utilize 5. TD is the number of periods that are utilized in the RS calculation.
6. Calculate for RS utilizing the number of periods directed by TD.
7. Repeat as every period closes.

This indicator is seeing past price movement. It isn't intrinsically predictive in nature.

Dynamic Momentum Index Example

In the chart below, the circumnavigated area shows a potential trade setup in Illinois Tool Works Inc. (ITW) utilizing the dynamic momentum index and horizontal price support. As price backtracked to test the previous swing low toward the beginning of April, the indicator gave an oversold perusing below 30. The trade setup was confirmed when price failed to close below the previous low, and the indicator began to rise over 30.

Traders could place a stop-loss order either below the previous swing low or below the latest swing low to prevent a loss in the event that the trade moves against them.

Dynamic Momentum Index Limitations

Overbought doesn't be guaranteed to mean the time has come to sell, nor does oversold fundamentally mean the time has come to buy. At the point when prices are falling an asset can stay in oversold region for quite a while. The DMI indicator might even move out of oversold region, yet that doesn't mean the price will rise altogether. Likewise, with an uptrend, the price could remain overbought for quite a while, and when DMI moves out of overbought region that doesn't be guaranteed to mean the price will fall.

While the indicator lags not exactly the RSI, there is still some lag. The price might have proactively run fundamentally before a trade signal happens. This means that the signal might show up great on a chart, yet it happened too late for the trader to capture the bulk of the price move.

Traders are urged to likewise consider whether the asset is going or trending, to assist with filtering trade signals. Different forms of analysis, for example, price action, fundamental analysis, or other technical indicators are likewise suggested.

Highlights

• The dynamic momentum index is an overbought/oversold indicator that involves less periods in its calculation when volatility is high, and more periods when volatility is low.
• At the point when the price moves out of overbought region it very well may be utilized as a short sale signal, on the off chance that the price is running or in a downtrend.
• At the point when the indicator is below 30 the price of the asset is considered oversold and when its over 70, the price is considered overbought.
• At the point when the price moves out of oversold region it very well may be deciphered as a buy signal, in the event that the price is going or in an uptrend.