Most traders will tell you “the trend is your friend” and for good reason. When trading on shorter timelines, fundamental data like earnings and margins generally matter less than they do for long-term investors. Instead, short-term traders usually look for momentum and volatility, using technical analysis to study price trends. One of these trend-tracking tools is the vortex indicator, which traders can use to help spot both trend reversals and continuations.
What Is the Vortex Indicator?
The vortex indicator might sound like a tool Bill Paxton used in Twister, but it’s actually a three-pronged momentum indicator that gives potential buy and sell signals based on recent price data.
The vortex indicator was designed by Etienne Botes and Douglas Siepman, who leaned heavily on the work of Welles Wilder and his True Range trading tool. Published in 2010, the vortex indicator is one of the newer technical momentum indicators, and even many veteran traders have limited experience with it. However, it does have the potential for spotting trend changes or continuations in volatile markets with relatively easy-to-interpret signals.
How Does the Vortex Indicator Work?
The vortex indicator combines three different factors into a single tool —the positive momentum line (VI+), the negative momentum line (VI-) and the True Range. The vortex indicator is a short-term trading tool, so sets of 14 or 21 periods are generally used on the asset price chart. The two lines are calculated using high, low and closing prices over the specified timeframe.
The VI+ and VI- lines represent the forces of buying and selling and their impact on the security being charted. The VI+ and VI- lines appear on the sub-chart, with the VI+ usually colored green and the VI- line colored red. When the VI+ line is higher, the asset price is in an uptrend. Likewise, the price is in a downtrend when the VI- line is higher.
How to Calculate the Vortex Indicator
You’ll need to calculate the True Range, VI+ value and VI- value to properly use the vortex indicator. Let’s start with the True Range.
True Range is the highest value of either:
- Low of current period minus most recent day’s close
- High of current period minus most recent day’s close
- Current period high minus current period low
Next, calculate the positive momentum and negative momentum using prices from the previous two periods. These variables are usually labeled as VM+ and VM- and written as absolute values.
- VM+ is found by taking the current high and subtracting the period’s previous low
- VM- is found by taking the current low and subtracting the period’s previous high
Once these values have been calculated, choose your timeframe. When using the vortex indicator, time horizons of 14, 21 and 30 periods are common.
Finally, take the VM+ and VM- results and divide them by the True Range over the selected timeframe. If you used a 21-day timeframe, your calculation would look like this:
- VI+ equals VM+21 / TR21
- VI+ equals VM-21 / TR21
The formula is a little too much for the back of a napkin, but trading platforms will typically fill in the variables for you when charting stocks with this indicator.
How to Use the Vortex Indicator in Charts
The vortex indicator may appear on the sub-chart below the candlesticks on a typical stock chart. Not every brokerage provides this indicator on their trading platform, so you’ll need to check to see if it’s available.
To use the vortex indicator, you’ll need to choose your timeframe for the VI+ and VI- calculations. Most brokers have a default timeframe of 14 days, but you can adjust longer or shorter depending on your goals and trading strategy.
How to Interpret the Vortex Indicator
The vortex indicator can be interpreted in the following ways:
- Trend reversals tend to occur when the two lines cross. For example, when the VI+ crosses the VI-, that’s considered a bullish signal.
- Trend continuations tend to occur when one of the lines remains elevated above the other. If the asset’s VI- has been consistently above the VI+ during recent trading sessions, it's the price downtrend could continue.
Example of the Vortex Indicator
Consider hypothetical stock XYZ, which has been trading in a volatile pattern for the last few weeks. You have a hunch that the price trend is about to break to the upside, so you might set up the vortex indicator on a 14-period timeframe. If the VI+ line crosses over the VI- line a few days later, that tends to indicate a buy signal, so you may follow through on your idea and purchase shares.
Possible Advantages of Using the Vortex Indicator
Here are the potential benefits of adding the Vortex Indicator to an investor’s toolbox:
- Trigger signals are relatively easy to interpret: A simple crossover sends the sell or buy signals with this indicator can make it easier to decipher for novice traders.
- Can identify continuations and reversals: Momentum indicators sometimes only assist in identifying continuations or reversals; the vortex indicator can be used to identify both.
- Smooths out volatile price data: When stocks are volatile, the vortex indicator allows some experienced traders to identify patterns behind the price gyrations, which can provide guidance in choppy markets.
Limitations of Using the Vortex Indicator
Here are some drawbacks of using the Vortex Indicator that traders should be aware of:
- False signals: No indicator is perfect, and the vortex indicator still sends its fair share of false signals.
- Loses efficiency as volatility lessens: When markets are flat or stuck in a tight range, the vortex indicator becomes less reliable. Like most momentum indicators, it’s built for volatile markets.
- Should be used with other indicators for a more complete picture: Even when markets are volatile, the vortex indicator should be paired with other momentum trading tools.
Find Momentum Reversals and Continuations with the Vortex Indicator
The vortex indicator can be useful because it can potentially identify reversals with bullish or bearish signals, along with trend continuations. Despite its versatility, it is by no means perfect and should be used in conjunction with other trend-following indicators. It’s more beneficial to choose two or three trading tools that work well together and use them to inform your trading decisions.
Frequently Asked Questions
Is the vortex indicator accurate?
The indicator sends helpful signals during trend reversals but is still prone to the occasional false alarm. It’s good practice to use it along with other indicators to better confirm the signals.
When is the vortex indicator most effective?
The vortex indicator is designed in volatile markets, but flat or range-bound markets tend to lessen its effectiveness.
What is the difference between ADX and vortex indicator?
The vortex indicator and Average Directional Index (ADX) are momentum indicators inspired by the work of Welles Wilder, but the ADX measures trend strength while the vortex indicator looks for reversal or continuation signals.
About Dan Schmidt
Dan Schmidt is a finance writer passionate about helping readers understand how assets and markets work. He has over six years of writing experience, focused on stocks. His work has been published by Vanguard, Capital One, PenFed Credit Union, MarketBeat, and Fora Financial. Dan lives in Bucks County, PA with his wife and enjoys summers at Citizens Bank Park cheering on the Phillies.