Quantiple Direction Index

16 Jun

This indicator indicates market trends by analyzing the following signals:

1. RSI which is a momentum oscillator
2. Directional Movement Index (DMI) which measures the direction of the movement
3. Price in comparison to EMA 13 and 21 to determine whether the trend is clear or there is an ambiguity
4. ADX that shows the strength of the momentum

Scoring logic

While we have kept the source code open which gives the scoring logic, for ease of the user, I am summarizing the scoring logic

A. We break down RSI and DMI into a 9 point scale (-4 to +4) from extremely bearish to bullish. Then we give equal weight to both and come out with a direction score.

B. We use EMA to determine if their is clarity in the price trend. While the direction is deduced from point A, if there is clarity we know that the confidence on the direction is high. If EMA 13 is higher than EMA 21 and the price is above EMA 13, then we assign it as a score of +1 as we get clear bullish trend. Similarly if EMA 13 is below EMA 21 and the price is below both the EMAs then we assign it a score of -1 as we get clear bearish trend. Anything else is considered as inconclusive and given a score of 0

C. We use ADX to determine the strength of the directional momentum. It is like acceleration. We use ADX score as an strength adjustment factor. If the value is above 25 - we multiply A+B by 1.25. Similarly we multiply it by 0.75 if the strength is weak and no change if the strength is neutral.

Finally this indicator categorizes market direction into five levels:

- Very Bullish
- Bullish
- Neutral
- Bearish
- Very Bearish

Scores range from +6 (very bullish) to -6 (very bearish), with the user setting thresholds for each category. The midpoint between Bullish and Bearish defines the neutral zone.

Again all the exact values are in the code and the user can also customize as per their trading system.

Why does it make sense to combine these different indicators rather than looking at them in isolation?

We give equal weight to RSI and DMI to derive the direction of the price movement. Using two different indicators provide a better confirmation on the direction. However, this alone is not sufficient.

We want clarity of the direction and for that we use the EMA score (please refer to point B above). If we have clarity, the probability of the direction being right goes up.

Once we know the direction, we want to know what is the strength of that direction. This point is very valuable for an option trader. This is where this indicator brings value.

Please note that by looking at these indicators in isolation one can get a sense of direction or a sense of strength of the direction. But, when you combine them, you get whether the direction move is with strength or not. If you are into option trading, you will clearly understand the rational behind it when you look at the trading rules provided in this description. For example if one knows that the direction is bullish (which one can potentially get from RSI or DMI), one can either buy a call or sell a put. But one knows that not only the direction is bullish, but it has the right acceleration (strength of the momentum), then one will assign higher probability of higher profit from buying call than from selling put.

To summarize we have combined indicators to achieve the following

1. Get confirmation from two different indicators on the direction of the price movement (RSI and DMI)
2. Confirm that the direction is clear (Price relative to EMA)
3. Combine with the strength of the direction (ADX)

Direction, clarity of the direction and the strength of the directional movement is a valuable trading indicator in our opinion.

Suggested trading rules

1. Short strangle strategy when the trend is neutral with one's usual option selling quantity. Equal quantity on put and call.
2. Full quantity short put and half quantity short call when the trend is bullish.
3. Full quantity short put and call long when the indicator is very bullish.
4. Vice versa for bearish ( full call short, half put short) and very bearish (full call short, put long)

Suggested to use 5 min timeframe for scalping, 15 min for intraday positions, 1 hour for weekly and monthly positions, and daily/weekly for investments.

The value of this indicator oscillates between +6 to -6. You can tweak the range for V bullish, bullish, bearish, and v bearish. The values in between will default to the neutral zone.

Disclaimers:

1. While the creator has used this in the live market, no claim is being made on its effectiveness or profit making ability. Please use it for trading only after you have tested it and are satisfied.
2. There may be thousands or millions of better trader in this world than the creator of this script. The creator makes no claim of his intelligence or trading ability.
3. The creator has no intention of selling this particular script now or in future. This is purely for community use and there's no intention to make any monetary profit from it.
4. The creator is not requesting or soliciting anyone to like or promote this script. The creator is also not asking anyone to give him any business now or in future even if they like this script and benefit from it.