Reprinted from Technical Analysis of Stocks & Commodities magazine. © 2009 Technical Analysis Inc., (800) 832-4642, [Link]

com
TRADING SYSTEMS

The Vortex Indicator

Reliability Is Harder Than It Looks

The search for a reliable technical indicator for consecutive zeroes or positive numbers placed in
trading a change in market direction seems to be two columns assigned for positive and negative di-
a never-ending quest. Ideally, such an indicator rectional movement. However, if these two strings
should be on time; neither lagging the market nor of numbers are summed after 14, 21, or 55 periods,
too sensitive. The Vortex Indicator was developed the larger value gives an indication of overall trend.
as a new directional movement indicator, drawing If this process is continued, the result can be seen on
inspiration in part from J. Welles Wilder’s directional a chart as two lines representing positive and nega-
movement indicator. The result is a simple but effec- tive directional movement. These will intersect and
tive indicator that can be used to develop intriguing cross during a change of trend and diverge wider and
trading ideas. wider as the strength of the trend increases. This is

A
the basis of Wilder’s Dmi.
fter thoroughly researching technical tools,
we concluded that the concept of the di- Inspiration from nature
rectional movement index (Dmi) offered The Vortex Indicator’s inspiration for another view
the most accurate way to identify trend on directional movement comes from an entirely dif-
direction or significant price moves in the market. The ferent source. Viktor Schauberger (1885–1958), who
concept of Dmi was best defined and described by J. is viewed as the father of “implosion technology,”
Welles Wilder in his classic 1978 book New Concepts was an Austrian forester, experimenter, and inventor.
In Technical Trading Systems. The result of his work is He sought to develop energy-producing machines
the now-famous and highly effective indicator, which that, through their shape, form, and motion, were
inspired the creation of our Vortex Indicator. able to mimic the power of nature’s processes. The
To understand the Vortex Indicator better, we must foundation of his work came from studying nature
describe directional movement. The idea is that the in- and analyzing the fluidic vortexes of water in rivers
dividual relationship between price bars provides clues and streams, and later in pipes and turbines.
to the direction of the trend or market. Wilder summed Using these concepts, we developed the idea that
it up thus: “Directional movement is the largest part of the flow and vortex motions of water in a river mimic
today’s range that is outside yesterday’s range.” those of the markets. Over the years, traders have
Positive directional movement is simply the portion made interesting comparisons and analogies to market
of a price bar that is above the high of the previous movement. The challenge was to translate this idea
bar. Negative directional movement is the portion of to the market.
the price bar that is lower than the previous low. The Figure 1 shows a stylistic vortex flow of water.
smaller of these two values is assigned a zero value. We visualized that similar vortex flows are present
The larger number is used to indicate if the market
is moving up (positive) or down (negative). In the
case of an inside bar (if neither the high nor the low
is higher or lower than the previous bar), a zero value
is assigned to both positive and negative direction.
The result will be a string of seemingly random

by Etienne Botes and Douglas Siepman Figure 1: a typical vortex flow

 Reprinted from Technical Analysis of Stocks & Commodities magazine. © 2009 Technical Analysis Inc., (800) 832-4642, [Link]
TRADING SYSTEMS

in the market, influencing the flow of the market (Figure 2).

By simply connecting the lows with consecutive highs as well
as highs with consecutive lows, we can see a vortex pattern in
Figure 2: vortex flows in the markets the market (Figure 3).
This may seem like a tenuous link, yet it served as the spark
of innovation for this discovery. Based on the simplicity of cal-
culating the distances between consecutive lows and highs, and
highs and lows, the Vortex Indicator was born (Figure 4). The
greater the distance from yesterday’s low to today’s high, the
stronger the upward (or positive) vortex. Similarly, the greater
the distance between yesterday’s high and today’s low, the stron-
ger the downward (or negative) vortex movement. As with the
Dmi, these relationships become more meaningful if a string of
FIGURE 3: VORTEX PATTERN IN THE MARKET. In connecting the lows with consecutive
highs and highs with consecutive lows, you can see a vortex pattern in the markets. upward and downward vortex relationships are summed.
How do we treat an inside bar? Remember, an inside bar is where
today’s high is lower than yesterday, and the low is higher than yes-
terday. Wilder believed that such a day represented zero directional
movement and assigned a zero value for both upward and downward
moves. For the Vortex Indicator, the calculated values for upward
and downward movement are included in the calculation.
This is the major difference between the Vortex Indicator
and Wilder’s Dmi: at no stage in the calculation of the indicator
are numerical values substituted for zeroes. Please refer to the
FIGURE 4: THE VORTEX INDICATOR. The greater the distance from yesterday’s low to today’s sidebar on page 25, “The Vortex Indicator With Excel,” for a
high, the stronger the upward (or positive) vortex. Similarly, the greater the distance between simple explanation of the calculations and construction of the
yesterday’s high and today’s low, the stronger the downward (or negative) vortex. indicator.

1.5
Interpreting it
In Figure 5 we have drawn the 14-period daily
+VI Vortex Indicator for crude oil. We have chosen
-VI
1.3 the 14-day parameter because Wilder used this
same parameter for the Dmi in his original
1.1 book. Note two lines (+VI and ‑VI) converging
and diverging in relation to one another, and
0.9 at times intersecting and crossing each other.
The interpretation is simple: When +VI is big-
ger and above ‑VI, the market is trending up.
0.7
+VI Similarly, if ‑VI is bigger and above +VI, the
-VI market is trending down. The crossing points
0.5 are the all-important potential trend change
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
points. When compared to the price chart
FIGURE 5: 14-PERIOD DAILY VORTEX INDICATOR FOR CRUDE OIL. +VI and -VI converge and diverge in relation of crude oil in Figure 6, note how the lines
to one another and sometimes intersect each other. When +V is greater than -V, the market is trending up. When -V
increasingly diverge as the trend strengthens
is greater than +V, the market is trending down. The crossing points are the potential trend change points.
and converge as the trend weakens.
All technical tools will indicate a clear trend.
150 In this regard, all technical indicators are al-
130 ways right. The significance and accuracy of
110 any indicator is tested at the point of a change
of a trend direction. All technical indicators are
90
bound to have some false signals before the
70
real direction is indicated. The key is to find
50 one that gives the least false signals but at the
30 same time does not lag the market too much.
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec The Vortex Indicator is effective in identify-
FIGURE 6: CRUDE OIL. As the trend strengthens, note the +VI and -VI lines increasingly diverge. As the trend ing the start, existence, or trend continuation
weakens, the +VI and -VI lines converge. in any market. The indicator can be used in
 Reprinted from Technical Analysis of Stocks & Commodities magazine. © 2009 Technical Analysis Inc., (800) 832-4642, [Link]

The Vortex Indicator with excel

Traders will recognize that the calculation for
the Vortex Indicator is in many ways similar to
J. Welles Wilder’s DMI. In the Excel spreadsheet
(sidebar Figure 1), the first calculation is for
the positive trending vortex movement +VM
column and starts in cell E3:

= ABS(B3-C2)

Column F calculates the negative trending

vortex movement –VM. The formula for cell
F3 is:

=ABS(C3-B2)

The daily calculations are volatile so the data

needs to be smoothed. This is done by deciding
on a parameter length for the Vortex Indicator.
For this example, we have chosen a 14-period
vortex. The formula is simply the sum of the
last 14 +VM values in cell G16:

=SUM(E3:E16)
SIDEBAR FIGURE 1: CALCULATING THE VORTEX INDICATOR USING AN EXCEL SPREADSHEET
The same for the –VM values in cell H16:

=SUM(F3:F16)
Finally, we need to calculate the ratio of +VM14 and ‑VM14
Next, we calculate the true range (TR) in cell I3: to the sum of the last 14 days’ daily true ranges. We do this in
cell K16:
=MAX(B3-C3,ABS(B3-D2),ABS(C3-D2)) =G16/J16

Next, we need to get the sum of the last 14 periods’ true range. Similarly, for cell L16:
Keep in mind if you want to change the parameter of vortex to 21, =H16/J16
34, or 55, you will also need to use the sum of the last 21, 34,
or 55 periods’ true range. In this case, we sum the true range in At this point, these two last columns can be used to draw the
cell J16: graph of the Vortex Indicator. —EB & DS
=SUM(I3:I16)

a number of ways: in combination with other indicators, as a spaced numbers that provide a good basis for testing. Again,
confirmation of a trend change, or as part of a larger system. longer parameters are favored as they are more robust and ac-
It can also be used on its own, as suggested by Wilder for the curate. However, it is up to the preference of the trader to decide
Dmi. The key is to focus on the crossing points of +VI and on a time frame and parameter that suits their approach best. If
‑VI. When the +VI14 crosses above the ‑VI14, a long position you choose a short time frame (like five minutes), we recom-
is initiated, and similarly for a short position if ‑VI14 crosses mend combining this with a long parameter — for example,
above +VI14. 34 or 55. Longer time frames and longer parameters result in
The Vortex Indicator can be used for any market, parameter, fewer false signals, but as with any indicator, the price to be
or time frame. It may be used for time frames as short as 15 min- paid is delayed entry.
utes or hourly, or for longer time frames such as daily or weekly As with any indicator or system, we recommend that you try
charts. Most technical indicators, including vortex, work better not to curve-fit too much; it’s more important to stick to one time
with longer time frames. Longer time frames such as weeklies frame and parameter. Keep in mind that trading system develop-
or monthlies can be used to establish larger macrotrends. In this ment is all about gaining one benefit for the sacrifice of another.
sense, vortex is the ideal tool for both short-term traders as well
as longer–time frame fund managers. Similarly, any parameter Trading idea
may be chosen, be it 13, 21, 34, or 55. To increase the accuracy of the crossing points of +VI and ‑VI,
Note that we suggest Fibonacci numbers. There is no magic we suggest you experiment with set-up techniques to filter and
to these numbers; they simply represent a set of conveniently limit taking false trades. Wilder suggested a trade setup for the
 Reprinted from Technical Analysis of Stocks & Commodities magazine. © 2009 Technical Analysis Inc., (800) 832-4642, [Link]
TRADING SYSTEMS

Dmi that can effectively be used for vortex. will help you filter out these false trades. As a matter of interest,
On the point or day of the crossing, the extreme high or using this technique will improve most systems or approaches
extreme low of the day should become your point of entry, despite the cost of delayed entry.
either long or short. You do not take a position at the close; you
must leave a “good till canceled” (Gtc) entry to go long at the Stop-loss and
high, or go short at the low of the daily bar that indicated the taking profits
crossing. If you have an existing long position, and the Vortex Wilder suggests trading the Dmi
Indicator indicates a short, the low becomes your point to exit from one crossing to the next,
and go short. If this does not occur, remain long. The indicator similar to a swing system. This
may turn back up to long, saving you a false stop and entry. We means the new long entry also acts
will explain this in detail in our trading examples. as a stop for a short and vice versa.
Even if ‑VI remains below +VI for a number of trendless This may not be the most efficient
bars, your point of going short is still that first original bar of approach, unless you have a very
the crossing. It may seem puzzling to delay an entry at a more long-term investment horizon. By
expensive price, either long or short. However, as in the case not leaving a predetermined stop-
of other indicators, the vortex is not always accurate, and this loss with your broker, you may be exposed to high risk in the
method will save you a significant number of false signals. event of a fast-moving market or an adverse event. Further, we
Further, it may happen that you are already holding a long recommend that you use a trailing-stop strategy to enable you
position. It is to your advantage to filter out a false short signal, to fully let your profits run.
and vice versa. By using a market-derived trailing stop, the size of your
In the case of a trendless sideways market, many such cross- profit is determined by the market itself. You may choose to
ings may be indicated, but using the same sort of trade setup experiment with a trailing stop-loss strategy derived from the
true range or average true range or adaptive permuta-
tions thereof. Fixed-percentage stops or stops based on
1.4
an arbitrary dollar figure are not recommended, as each
1.3
+VI
market has different characteristics and volatilities.

Trading examples
1.2
1.1 We will now show you how to trade the change of trend
Example 1 Example 2 Example 3
1
direction. As an example, we have used the Nymex crude
oil future (light sweet) of 2008. We have constructed a
0.9 Vortex Indicator using daily bars as our time frame and
0.8 a 14-period parameter.
-VI Looking at the bar chart for 2008 (Figure 6 on page
0.7 24), three obvious opportunities stand out. First, there
0.6 is a brief opportunity to go short at the beginning of the
Jan Feb Mar year, followed by a shallow-angle bull market headed
FIGURE 7: THREE EXAMPLES, THREE TRADING SITUATIONS into July. Readers may concur that any shallow-angle
market is one of the most difficult and frustrating mar-
kets to trade. Finally, there is an extended bear market
95
to the end of the year with a nasty, unexpected spike to
94 $130 in September. The vortex graph for the same pe-
riod shows an opportunity for a short whenever the red
93 ‑VI line is above the blue +VI and vice versa. As with
any indicator, some false turning points are indicated,
92
Leave order to especially during that shallow-angle bull market in the
91 go short at first part of the year.
the low We will focus on three examples to illustrate differ-
90 ent trading situations (Figure 7). In example 1 (Figure
Short triggered 8), on January 15, 2008, the Vortex Indicator turned to
89
indicate a short signal. On the day of the crossing, the
88 low of the session was at 90.98, with a market close at
14 Jan 15 Jan 16 Jan 17 Jan 18 Jan 22 Jan 91.90. The procedure was to leave an order with your
FIGURE 8: EXAMPLE 1. On January 15, 2008, the vortex turned to indicate a short signal. On the broker to go short at 90.98. This was triggered the next
day of the crossing, the low of the session was at 90.98 and the market closed at 91.90. You would day. By using a trailing-stop strategy, this can be a
place an order with a broker to go short at 90.98. profitable trade.
 Reprinted from Technical Analysis of Stocks & Commodities magazine. © 2009 Technical Analysis Inc., (800) 832-4642, [Link]
Leave order to go TRADING SYSTEMS
long at the high
96
Long triggered
94 to breach this level. During these days, we learned not
to adjust or lower the original entry point.
92 The next turning point, which was displayed in
example 3 (Figure 10), was to show how a false sig-
nal is filtered. On March 20, 2008, the 14-day vortex
90
showed a turning point for a short signal. The low of the
session was 98.65. If you are still long from the previ-
88 ous signal, this point will become a stop and reverse.
However, on the following two days, the market lows
86 were only 99.95 and 99.13 before the Vortex Indicator
08 Feb 11 Feb 12 Feb 13 Feb 14 Feb 15 Feb turned back to a long signal again. In this case, your
FIGURE 9: EXAMPLE 2. A long signal is given on February 11, 2008. The high was at 94.72. Note order to go short was never traded. Cancel the order
that if you had placed a “good till canceled” order to buy at 94.72, your trade would only have been and continue to remain long.
filled three days later. During the long bear market stretching from July 17,
2008 (Figure 11), the two false buy crossings could be
filtered in the same way, including that irregular spike
110
to $130. For this reason we recommend using a type
of trailing stop to limit losses or lock in profits, even
108 during this well-defined bear market. Though you may
still get stopped out at times during this trend, in most
106 cases it will be with a profit.
If you do get stopped out, you need to experiment
104 with techniques to reenter the same trend, as the Vortex
Indicator may still indicate a continuation of the original
102 trend at the end of the session. We suggest using the same
Leave order method to enter a new trade as described previously.
100 to go short Leave a reentry order at the low or high of the bar you
at the low Short not triggered have been stopped out on. Leave this order unchanged
98 until it is traded, or until the Vortex Indicator indicates
19 Mar 20 Mar 24 Mar 25 Mar 26 Mar 27 Mar a swing to the opposite direction. In that case, simply
cancel the order and enter a new entry on the opposite
FIGURE 10: EXAMPLE 3. On March 20, 2008, the 14-day vortex shows a turning point for a short
high or low.
signal. The low was at 98.65. However, the short was never triggered since the price did not reach
98.65. So you would cancel the order and continue to remain long.
Spinning vortex
It is up to the creativity of the trader to use the
1.5000 Vortex Indicator as the foundation of new trading
-VI ideas. Always remember to backtest your approach
1.3000 before implementing your idea, and always keep
your trading recipe as simple as possible.
1.1000
Etienne Botes and Douglas Siepman are the man-
agers of Vortex FX, a Switzerland-based specialist
0.9000 forex fund. They can be reached by email at etienne@
[Link], douglas@[Link], or at
0.7000 their website, [Link].
+VI
0.5000
Jul Aug Sep Oct Nov Dec Suggested reading
Evens, Stuart [1999]. “Directional Movement,”
FIGURE 11: FALSE SIGNALS. Between July 2008 and December 2008, there were two false buy crossings.
These signals can be filtered in the same way as in Figure 10.
Technical Analysis of Stocks & Commodities,
Volume 17: February.
Wilder, J. Welles [1978]. New Concepts In Technical
In example 2 (Figure 9), a long signal was given on February 11, 2008, Trading Systems, Trend Research.
the high being 94.72. By leaving a Gtc order to buy at 94.72, this level
was only traded three days later. The market on February 12 and 13 failed S&C