The vortex indicator is a reliable trend-following tool that signals the formation of a new trend or the continuation of an existing trend. It can be used across all financial markets, although it’s mainly used for trading stocks. It consists of two oscillators measuring upward and downward movement and includes two trend movement lines plotted in a separate window, called the +VI (positive trend movement) and the –VI (negative trend movement). The indicator generates buy and sell signals that are designed to capture the most dynamic trending action, higher or lower. It should be used with other studies and filters, like price action, to reduce false signals. The vortex indicator can be used in almost all time frames and is market-neutral, but it works better when used on longer time-frames like daily charts.

How to Use the Vortex Indicator for Trading Stocks

Introduction

Knowing when to enter the market is crucial in trading and investing. Early entry into emerging trends can maximize price swings and increase profits. One reliable trend-following tool that can help predict potential trend inceptions is the vortex indicator. In this article, we’ll discuss the vortex indicator and how it can be used for trading stocks.

What is the Vortex Indicator?

The vortex indicator (VI) is a relatively new trend-following tool that consists of two oscillators measuring upward and downward movement. It signals the formation of a new trend or the continuation of an existing trend and can be used across all financial markets. The vortex pattern on a chart can be seen by connecting the lows in the candles with the highs in consecutive candles and vice versa. The bigger the difference between the low of a candle and the next candle’s high, the stronger the upward vortex (VM+), and the bigger the difference between the high of a candle and the next candle’s low, the stronger the downward vortex (VM-). The vortex indicator includes two trend movement lines plotted in a separate window, called the +VI (positive trend movement) and the –VI (negative trend movement). Positive trend movement represents the distance of the current period high from the previous period low, while negative trend movement represents the distance of the current period low from the previous period high. The indicator uses the average true range in its calculation to measure volatility, and it normalizes the positive and negative trend movements by dividing them by the true range.

Applying the Vortex Indicator

The vortex indicator can be used in almost all time frames and is market-neutral. Longer time frames, such as daily charts, produce better results as “price noise” in lower time frames can create false signals. When using the indicator on very short time-frames, such as 5-minute charts, increase the indicator’s value to 21 or 30 to smooth out lateral price movements.

Trading with Vortex Indicator

The vortex indicator plots two oscillating lines, one for identifying positive trend movement and the other for identifying negative price movement. Crossovers between the lines trigger buy and sell signals that are designed to capture the most dynamic trending action, higher or lower.

Simplest Signals

The simplest signals the indicator generates are crossovers between positive trend movement VM+ and the negative trend movement VM-. A crossover above the negative vortex signals an upward trend, while a crossover below the positive vortex signals a downward trend.

Filtering False Signals

The vortex indicator generates false signals in congested or mixed markets. Adjusting the indicator to longer periods will lower the frequency of false signals but will generate delayed entries. Shortening the vortex period will lead to many crossovers that fail to generate significant trend movement. Stocks with high volatility will respond better to shorter-term settings, while slow-moving stocks will respond better to longer-term settings. The indicator works best when used in conjunction with other studies and filters, such as price action.

Applying Filters

A simple moving average (SMA) can be added as a long-term trend filter. Buy trades are triggered if the price is above the SMA, and positive trend movement crosses above negative trend movement. Conversely, sell trades are triggered if the price is below the SMA, and negative trend movement crosses above positive trend movement. A 200-period SMA is a good long-term filter.

Increasing Effectiveness

To reduce false signals and increase effectiveness, consider using the following filters:
– Place trades only when either positive trend movement VM+ or negative trend movement VM- is above the 1.1 level.
– Wait for the positive line to go above 1.1 for a long entry and wait for the negative line to go below 0.9 for a short entry.
– Place a limit order at the high or low of the candle where a crossover occurred, instead of entering when the crossover happens.
– Ignore setups with multiple crossovers in a short period, which indicates market indecision.
– Look at the range between the vortex lines to determine range bounding markets.

Conclusion

The vortex indicator is a useful trend-following tool that predicts potential trend inceptions. Its oscillators measure upward and downward movement, and its trend movement lines plot positive and negative trend movement. Although it can be used across all financial markets, it is most effective when used for trading stocks on longer time frames. Using filters such as SMAs and waiting for positive or negative trend movement signals can reduce the occurrence of false signals and increase effectiveness. By following these guidelines, traders and investors can improve their chances of profitable trades.