First published in the January 2010 edition of Technical Analysis of Stocks & Commodities, the Vortex Indicator (VI) was invented by Swiss-born Etienne Botes and Douglas Siepman. The two drew inspiration from the work of Alexander Elder, one of Forex’s best-known authors. Since then, this indicator has gained immense popularity in the Forex group, but retail traders have been a little late to the show.
I’m new to the Vortex Indicator, but it seems promising to apply to my charts. Perhaps this will be a new tool in my trading toolbox!
But the question remains: Should it be in your toolbox? I’d say yes; why not? Keep reading to see how to use this indicator to bank some profits.
Vortex Indicator Summary
- The Vortex Indicator helps to identify reversal patterns and confirm current trends.
- The intersection between the green and red lines are buy and sell triggers
- Buy when +VI crosses above -VI
- Sell when -VI crosses above +VI
- Please don’t use this indicator in isolation; it works great when combined with moving averages.
- It works best in markets with a strong trend in either the up or down direction
What Does the Vortex Indicator Do?
The Vortex Indicator is a technical indicator that traders use to signal the start of a new trend or the continuation of an existing trend.
When you pop the hood, you’ll see that the Vortex Indicator is an oscillator consisting of two lines: +VI and -VI. Like candlesticks, a green line (+VI) represents bullish buying pressure, and a red line (-VI) represents bearish selling pressure.
VI+ and VI- are typically graphed independently below a candlestick chart. Your money is made where the two lines intercept, acting as your buy and sell signals.
History is essential for this indicator, two days worth, to be exact. What you see on the chart represents the previous two days’ highs and lows.
A bullish trend is characterized by the distance from the last 2-day low to the current high. Alternatively, a bearish trend is strong if the distance between the current low and the previous high is large.
Directional Movement
I need to talk about directional movement to help you better understand the Vortex Indicator. Wilder states, “Directional movement is the largest part of today’s movement range that lies outside yesterday’s range.”
If you’re still confused, let me simplify: Price bars should correspond with the trend’s general direction.
For example, positive directional movement is the part of the bar that lies above the previous bars high. On the other hand, negative directional movement is the part of the price bar that lies below the previous minimum.
How to Trade Using the Vortex Indicator
As I mentioned above, you will want to buy when the +VI line (green) crosses the -VI line (red) from bottom to top. If shorting is more your style, your entry is when the -VI line (red) crosses the +VI line (green) from top to bottom. To a large extent, most platforms default to 14, but experienced traders can alter this accordingly.
Consider the low as your exit point if you’re in a long position and the Vortex Indicator points to a short position. Similarly, you could turn around and enter a short position once you unloaded your long.
As you can see in the image above on the 5-minute MES chart, there’s a strong sell signal when the -VI line crosses above the +VI line.
Your entry is confirmed with the PSAR dots above the bullish bear candle. This would have been a fantastic short entry – which I sadly missed, as the MES washed over 70 points!!
False Signals
I hate to burst your bubble, but like any indicator, it has its pitfalls in the form of false signals. To avoid these potentially costly false signals, I highly suggest using it in conjunction with other indicators like MACD.
Some of my favorites include the PSAR oscillator and the 21-day moving average. I’ve also heard of many traders using the 100-day SMA to ensure they’re trading in the overall trend direction.
Like the PSAR indicator, the Vortex Indicator works best in markets trending up or down. You won’t have much luck trading with this indicator in range-bound or choppy markets.
A straightforward trick in a choppy market is to increase the number of periods used, using, for example, 25 periods instead of 14.
Traders love this indicator because it can be used on any time frame, security, time of day, and trading strategy. When you learn how the stock market works, the sky’s the limit with the Vortex Indicator. I challenge you to try it out!
Final Thoughts on Vortex Indicator
Traders love this indicator because it can be used on any time frame, security, time of day, and trading strategy. When you learn how the stock market works, the sky’s the limit with the Vortex Indicator. I challenge you to try it out!
The main limitation of the Vortex Indicator is that it will give a lot of false signals in a sideways trending market. This is especially true if you apply it to smaller time frames like the one and 5-minute charts.
But, this can easily be avoided if you identify the trend’s direction and trade accordingly. The Vortex Indicator is just one among thousands you can choose from.
I would not trade with the VI alone. But I most certainly would use it with my two favorite indicators, the PSAR and 21-day MA. That works for me.
