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, who is one of the best-known authors in Forex. Since then, this indicator has gained immense popularity in the Forex group, but retail traders have been a little late to the show.
Personally, I’m new to the Vortex Indicator, but it seems promising applied 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 you can use this indicator to bank some profits.
Table of Contents
A Summary of the Vortex Indicator
- 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
- 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 identify 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. Similar to 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 when it comes to this indicator, two days worth to be exact. What you see on the chart is a representation of 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
To help you better understand the Vortex Indicator, I need to talk about directional movement. According to Wilder, “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
Like 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 the top to bottom. To a large extent, most platforms default to 14, but experienced traders can alter this accordingly.
If you’re currently in a long position and the Vortex Indicator points to a short position, consider the low as your exit point. 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-mintute 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 it’s 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 favorite’s include the PSAR oscillator and the 21-day moving average. I’ve also heard of a lot of 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 that are 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.
A great way to swing trade is use hourly candles and a daily vortex indicator (multi-time frame analysis rocks!) Checkout TrendSpider for yourself.
The Versatility of the Indicator
Traders love this indicator because it can be used on any time frame, security, time of day and trading strategy. The sky’s the limit with the Vortex Indicator when you learn how to stock market works. I challenge you to try it out!
Final Thoughts
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’re applying it to smaller time frames like the 1 and 5-minute charts.
But, this can easily be avoided as long as you identify the direction of the trend and trade accordingly. The Vortex Indicator is just one among thousands you can choose from.
Personally, I would not trade with the VI alone. But, I most certainly would use it with my favorite two indicators, the PSAR and 21-day MA. That works for me.
Are you interested in learning more? Well you’re in the right place, we’ve got steep discounts now on our memberships. What do you have to lose?
