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Directional Market Efficiency [QuantAlgo]

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๐ŸŸข Overview

The Directional Market Efficiency indicator is an advanced trend analysis tool that measures how efficiently price moves in a given direction relative to the total price movement over a specified period. Unlike traditional momentum oscillators that only measure price change magnitude, this indicator combines efficiency measurement with directional bias to provide a comprehensive view of market behavior ranging from -1 (perfectly efficient downward movement) to +1 (perfectly efficient upward movement).
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The indicator transforms the classic Efficiency Ratio concept by incorporating directional bias, creating a normalized oscillator that simultaneously reveals trend strength, direction, and market regime (trending vs. ranging). This dual-purpose functionality helps traders and investors identify high-probability trend continuation opportunities while filtering out choppy, inefficient price movements that often lead to false signals and whipsaws.

๐ŸŸข How It Works

The indicator employs a sophisticated two-step calculation process that first measures pure efficiency, then applies directional weighting to create the final signal. The efficiency calculation compares the absolute net price change over a lookback period to the sum of all individual bar-to-bar price movements during that same period. This ratio reveals how much of the total price movement contributed to actual progress in a specific direction.

The directional component applies the mathematical sign of the net price change (positive for upward movement, negative for downward movement) to the efficiency ratio, creating values between -1 and +1. The resulting Directional Efficiency is then smoothed using an Exponential Moving Average to reduce noise while maintaining responsiveness. Additionally, the system incorporates a configurable threshold level that distinguishes between trending markets (high efficiency) and ranging markets (low efficiency), enabling regime-based analysis and strategy adaptation.

๐ŸŸข How to Use

1. Signal Interpretation and Market Regime Analysis
  • Positive Territory (Above Zero): Indicates efficient upward price movement with bullish directional bias and favorable conditions for long positions
  • Negative Territory (Below Zero): Signals efficient downward price movement with bearish directional bias and favorable conditions for short positions
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  • High Absolute Values (ยฑ0.4 to ยฑ1.0): Represent highly efficient trending conditions with strong directional conviction and reduced noise
  • Low Absolute Values (ยฑ0.1 to ยฑ0.3): Suggest ranging or consolidating markets with inefficient price movement and increased whipsaw risk
  • Zero Line Crosses: Mark critical directional shifts and provide primary entry/exit signals for trend-following strategies

2. Threshold-Based Market Regime Classification
  • Above Threshold (Trending Markets): When efficiency exceeds the threshold level, markets are classified as trending, favoring momentum strategies
  • Below Threshold (Ranging Markets): When efficiency falls below the threshold, markets are classified as ranging, favoring mean reversion approaches

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3. Preset Configurations for Different Trading Styles
  • Default
    Universally applicable configuration optimized for medium-term analysis across multiple timeframes and asset classes, providing balanced sensitivity and noise filtering.
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  • Scalping
    Highly responsive setup for ultra-short-term trades with increased sensitivity to quick efficiency changes. Best suited for 1-15 minute charts and rapid-fire trading approaches.
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  • Swing Trading
    Designed for multi-day position holding with enhanced noise filtering and focus on sustained efficiency trends. Optimal for 1-4 hour and daily timeframe analysis.
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๐ŸŸข Pro Tips for Trading and Investing

โ†’ Trend Continuation Filter: Enter long positions when Directional Efficiency crosses above zero in trending markets (above threshold) and short positions when crossing below zero, ensuring alignment with efficient price movement.

โ†’ Range Trading Optimization: In ranging markets (below threshold), take profits on extreme readings and enter mean reversion trades when efficiency approaches zero from either direction.

โ†’ Multi-Timeframe Confluence: Combine higher timeframe trend direction with lower timeframe efficiency signals for optimal entry timing.

โ†’ Risk Management Enhancement: Reduce position sizes or avoid new entries when efficiency readings are weak (near zero), as these conditions indicate higher probability of choppy, unpredictable price movement.

โ†’ Signal Strength Assessment: Prioritize trades with high absolute efficiency values (ยฑ0.4 or higher) as these represent the most reliable directional moves with reduced likelihood of immediate reversal.

โ†’ Regime Transition Trading: Watch for efficiency threshold breaks combined with directional changes as these often mark significant trend initiation or termination points requiring strategic position adjustments.

โ†’ Alert Integration: Utilize the built-in alert system for real time notifications of zero-line crosses, threshold breaks, and regime changes to maintain constant market awareness without continuous chart monitoring.

Penafian

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