The Vortex indictor is a still not an overly well-known technical analysis indicator, however, is gaining growing popularity amongst traders. In the world of indicators, it is relatively young, having been defined in 2010 by Etienne Botes and Douglas Siepman in Technical Analysis of Stocks and Commodities. The analysis builds on prior work done on Directional Movement by Welles Wilder, a famous technical analyst.
In this guide, we’re going to take a look at:
The Vortex Indicator is a technical analysis indicator that is primarily used to identify changes in trends (that is trend reversals) but can also be used to corroborate trends that are currently in place.
The vortex indicator is constructed from the highs and the lows from the last two trading periods (for example the past two trading days). The distance from the current period (day) high to the prior period (day) low signals a positive movement in trend. The measure between the current period low and the preceding period high defines a negative trend movement. This can be seen in Figure 1 below.
We will look at the detailed calculation of the Vortex Indicator below, but for now we will look at how we can profit from the indicator, by looking at Vortex Indicator trading strategies.
The Vortex Indicator can be used to give direct buy and sell signals and with a robust risk management strategy can generate winning trades and solid profits.
In this first example in the chart below (Figure 2), the Votrex Indicator gave a negative signal with the +VI crossing below the -VI on 25th February 2020. This was a very early signals and presented a great entry price for a shirt at the start of the global spread of thee COVID-19 pandemic. A stop would be placed above the swing high from February and a trailing stop-loss could be used.
Alternatively, an exit could have been signalled by the Votrex Indicator, as we will refer to in Example 2 below.
Figure 2: Daily S&P 500
Buy signals can be equally as profitable, as below.
Example 2: Vortex Indicator Strategy
In this next example, we would use the crossover of the Vortex Indicator as a buy signal in on 6th April 2020. This could have also been used as an exit signal for the short position in Example 1 above. Again, entering a long position here with a stop-loss below the recently set swing low from 1st April would have produced a strong profit. Again, a trailing stop could have been employed, or the Vortex Indicator negative crossover on14th May.
Figure 3: Daily S&P 500
However, as can be seen in May, June and September, sometimes there are less useful signals, and below in Vortex Indicator Strategies section we look at techniques and overlays that can help avoid these less profitable signals.
There are three steps in the calculation for the Vortex Indicator
To summarise the calculation, the Vortex Indicator rejects positive and negative trend movement adjusted for volatility (defined by the Welles Wilder’s True Range).
So, the main strategy as we highlight in our examples above is to use crossover signals to enter long and short positions. However, this can lead to unprofitable signals in more sideways markets. There are techniques and overlays that can be employed to try to avoid these unprofitable signals.