By Vishal Dalvi, CMT
Fusion-Trend Indicator
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Fusion-Trend Indicator
There is no Holy Grail indicator for Trend identification, but I have tried to create an Indicator which can accurately identify Up-trending, sideways, and down trending Markets using a combination of multiple indicators as defined below. The typical time horizon of trend using these parameters is 6 months and the change of trend takes 2-3 months.
The following sub section explains the functions and indicators used in Fusion Trend calculation:
RSI
RSI (Relative Strength Index) measures the speed and magnitude of a security’s recent price changes to evaluate momentum and also overvalued or undervalued conditions in the price of that security. I have used 28 period RSI.
ADX
ADX (Average Directional Index) measures the strength of trend over time regardless of direction. The other two output parameters PDI (Positive Direction Index) and NDI (Negative Direction Index) determine the strength of the trend in positive and negative direction. I have used 28 period ADX.
Efficiency Ratio
Efficiency Ratio measures the quality of price move between points A and B, by comparing the total distance covered from point A to point B with respect to net move between these two points. I have calculated this indicator for 28 periods.
Moving Averages
This function calculates four different simple moving averages. The idea is to assign different weightages to relative position of price and different moving averages. I have calculated 5 period, 10 period, 15 period and 30 period simple moving averages.
Ichimoku Crossovers
The Ichimoku Cloud, also known as Ichimoku Kinko Hyo, is a versatile indicator that defines support and resistance, identifies trend direction, gauges momentum and provides trading signals. In this section we have used IM to determine trend direction by comparing the relative position of Convergence and Base line and measure momentum by calculating the number of crossovers between Convergence and Base line. Standard 9-period and 26-period are used for calculation of Convergence and Base line and look back period for number of crossovers is 28.
Short Term Trend Indicator Calculation:
We merge the above 4 indicators to make a composite score of Trend defined as Sig1 using the following logic:
- RSI: if ( RSI > 50 ) then ScoreRSI = 1
- Else ScoreRSI = -1
- ADX: if ( (PDI – NDI > 5) and (PDI > 20) and (ADI > 20) ) then ScoreADX = 1
- Elseif ( (NDI – PDI > 5) and (NDI > 20) and (ADI > 20) ) then ScoreADX = -1
- Else ScoreADX = 0
- Efficiency Ratio: If ER > 0.3 then ScoreER = 3
- Elseif ER > 0.2 then ScoreER = 2
- Elseif ER > 0.05 then ScoreER = 1
- Elseif ER > -0.05 then ScoreER = 0
- Elseif ER > -0.2 then ScoreER = -1
- Elseif ER > -0.3 then ScoreER = -2
- Else ScoreER = -3
- Moving Averages: We start with ScoreMA = 0 then
- If PriceLast > MA30 add 0.36 to score and then
- If PriceLast > MA15 add 0.27 to score and then
- If PriceLast > MA10 add 0.21 to score and then
- If PriceLast > MA5 add 0.16 to score
Finally, if the ScoreMA > 0.7 then round it up to 1
-
- Elseif ScoreMA < 0.3 then round it down to -1
- Else make ScoreMA = 0
- IchiMoku: if ( (number of Conv Base crossovers < 2) and (Conv > Base) ) then ScoreIM = 1
- Elseif if ( (number of Conv Base crossovers < 2) and (Conv < Base) ) then ScoreIM = -1
- Else ScoreIM = 0
Composite Score = ScoreER*( ScoreRSI + ScoreADX + ScoreMA + ScoreIM ) which could have a value between -12 to -12
tempSig1 = 14-day simple moving average of Composite Score.
Long Term Trend Indicator Calculation
This indicator compares the Highest High and Lowest Low of last 5 days with Highest Close and Lowest Close in each of the last 12 months (20 trading days for each month) to compute relative progress of price in last 1 year.
- If ( (5 day high > Highest close of month i ) and (5 day low > Lowest close of month i ) ) then + 1 score to that particular month
- Elseif ( (5 day high < Highest close of month i ) and ( 5 day low < Lowest close of month i ) ) then – 1 score to that particular month
- Else 0 score to that particular month
We add the score given to all 12 months to calculate Sig2 which can have a value between -12 and +12. As a final check, change the value of Sig2 only if price is also changing in the same directions else retain the previous day value of Sig2.
Combining Short Term and Long-Term Indicators
Based on the values of Sig1 and Sig2, we determine the change in trend according to the following logic:
- If tempSig1 > 4 and Sig2 > 4 and present trend = -1 (negative), then new positive trend starts
- Elseif tempSig1 < -4 and Sig2 < -4 and present trend = 1 (positive), then new negative trend starts
From the day, a new trend starts we start averaging the value of tempSig1 using exponential moving average with a maximum period of 30 days to get smoothened value of Sig1.
Now Fusion-Trend = Sig1 + Sig2
but if Sig1 and Sig2 are of opposite sign, we make Fusion-Trend = 0,
also, if Present Trend and Sig2 are of opposite sign, we make Fusion-Trend = 0
Plotting the Fusion Trend Indicator – Nifty
The chart shows how the indicator is able to respond according to underlying trend change. A value above 0 denotes an uptrend and below 0 shows a downtrend. Also there are phases where the indicator value will persist to be 0, which signifies no trend in the market.
The indicator can have several applications
- Broad Trend Filter in strategies
- Position sizing based high and low values
- Entry/Exit signals
- Identifying Reversal zones – (In an uptrend, a move back to zero can be used for anticipating a reversal trade)
- Ranking stocks for choosing in the portfolio
There are several variations possible in terms of designing the final indicator. One can try several changes with Data sampling period and Indicator period to suit ones time frame or also add/delete some indicators to make it some suitable for ones style of trading, investing. The intention of the paper is not to give you a perfect indicator but to demonstrate how a composite indicator can be constructed combining several individual indicators.
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Originally posted 6th September 2024
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