Spot Price Reversals with the DeMarker Indicator
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The DeMarker indicator (also known as simply DeM) is an oscillator that derives its values by comparing the maximum and minimum prices achieved in the current time period with the equivalent prices achieved in the previous period. From this comparison, the indicator attempts to assess the directional bias of the market. At the same time, it indicates overbought and oversold conditions, and from these, attempts to identify points of trend exhaustion.
It is broadly based on principles espoused by technical analyst Tom DeMark, though the original indicator used no smoothing. The version in MetaTrader 4 uses simple moving averages to smooth component values, as we shall see. Though the indicator was originally devised with daily price bars in mind, it should be applicable to any time frame you are interested in, since it is based on relative price data.
Calculating the DeMarker Oscillator
Unlike the Relative Strength Index — perhaps the best known oscillator — the DeM does not concern itself with closing levels. Instead, it focusses on intra-period highs and lows. The DeM oscillator looks at the high and low of the current bar on a chart and how they compare to those of the previous bar.
If the current bar has more extreme levels, a value is stored. If the magnitude of the high and low is less extreme than in the previous bar, a value of zero is recorded. We use these values over a look-back period (customarily 14 bars) to give us a numerator and denominator. Finally, we calculate the DeMarker value by dividing the numerator by the denominator.
Let's break this down into its component steps.
First, we want to look at the high values. So over our number of periods, N, we look at each bar and see how the high compares to the previous high. If the current high is smaller than the previous high, we record a value of 0. If it is greater than the previous high, we record the difference between the two as our value. We call these values DeMMAX. Our numerator is a simple moving average of the DeMMAX values over the period N.
Now, we also look at our low values. We look at each bar and see how the low compares to the previous low. If the current low is higher than the previous low, we record a value of 0. If the current low is lower than the previous low, we record the difference between the two as our value. We call these values DeMMIN. We take a simple moving average of these values over the period N. We then add this to the numerator to give us our denominator.
We can sum this all up with the DeMarker indicator formula, which is as follows:
DEM = SMA(DeMMAX) [SMA(DeMMAX) + SMA(DeMMIN)]
The equation yields values bounded between 0 and 100. Values of the indicator above 70 are considered to suggest overbought territory. Values of the indicator below 30 are considered to suggest oversold territory.
Let's now take a look at using the indicator in MT4.
Using the DeMarker Indicator in MetaTrader 4
When you download MT4, the DeMarker oscillator is included as one of the indicators that come as standard with the platform. You will find it in the Oscillators folder when you look in MT4's Navigator, as you can see from the image below:
Image source: MetaTrader 4 platform, 29 August 2017
When you double-click on DeMarker, you are presented with the Parameters window, as shown. The key parameter value that you can set is the Period, which has a default value of 14 in MT4.
In the image below, I've added the DeMarker indicator to an hourly USD/CHF chart:
Image source: MetaTrader 4 platform, price data from Admiral Markets, hourly USD/CHF chart, 22 August 2017 to 29 August 2017
As you can see, the oversold and overbought regions, of 0.3 and 0.7 respectively, are marked on the DeMarker indicator Forex histogram as white dotted lines.
DeMarker Indicator Trading Strategy
DeMarker trading strategy is basically a contrarian approach, seeking reversals in price within a confirmed trend.
Though the indicator marks overbought and oversold regions, these are not in themselves enough to predict a reversal. Generally speaking, overbought and oversold simply mean unusually high and low prices judged by the sample data included in the look-back period. Rather than simply presaging a reversal, moving into these regions may in fact be a sign of the overall trend. Strongly overbought tells us there is buying pressure. Strongly oversold tells us there is selling pressure.
So how do we use the overbought and oversold indications to help us better understand what is going on in the market?
First of all, we need to look at how long the market remains in overbought or oversold regions in order to make a judgement call on whether the market is merely ranging, or in a mild trend or a strong trend.
The amount of time that the market spends in overbought or oversold territory gives us insights as to whether the market is in a trend or not. If a market stays for an extended period in extreme overbought levels, it confirms we are in an uptrend, for example. If a market stays at slight overbought levels — say, above 50, but below 70 — for an extended period, it suggests a modest uptrend.
With the default value of 14 periods, we might say levels above 70 are indicative of the market being in extreme overbought territory and below 30 of being in extreme oversold territory. As long as the indicator remains in these areas, we should be wary to take a position, as directional pressure appears to remain in place.
Ideally, we are looking to buy into temporary drops in the price within an overall uptrend, or sell into temporary spikes within an overall downtrend. One way we can identify these kind of opportunities is by looking for the indicator to move out of extreme overbought or oversold regions.
Have a look at the daily USD/CHF chart below:
Image source: MetaTrader 4 platform, price data from Admiral Markets, daily USD/CHF chart, 15 March 2017 to 30 August 2017
The green dotted line on the main price chart is a 14-day SMA. This is to help us get a handle on the overall trend. When the price is below the SMA, it suggest a downtrend. When the price is above the line, it suggests an uptrend.
The orange vertical lines show some circumstances when the DeMark indicator has moved back out of extreme oversold or overbought regions. The first three are times when the indicator has been in extreme oversold territory and then risen back into more neutral levels.
At such times, we might suspect there is a temporary easing in the selling pressure. As soon as the indicator rises above 0.3, we buy the market, provided you can get in below 0.5. Bear in mind that you are looking for temporary reversals and need to move swiftly to take profit. A target level might be the next point the indicator breaks above 0.6 in such a circumstance.
Bear in mind that recommended values are really just a suggested starting point. Rather than just ploughing ahead with these values and trusting in their effectiveness, it is better to take a more critical approach and determine what works for you in practice. This means experimentation and for that you need a risk-free avenue for your practice trades. The best way to do that is use a Demo Trading Account.
The larger the number of periods you use, the smoother the curve of the DeMarker indicator. The smaller the number of periods, the more responsive the curve. For smaller periods, which gives sharper oscillations, you might want to consider a higher boundary for overbought and a lower boundary for oversold. Similarly, with larger periods that yield shallower oscillations, you may want to consider a lower boundary for overbought and a higher one for oversold. For example, using a value of 18 for the period, you might want to consider 40 as oversold and 60 for overbought. See what works best for you.
Though the DeMarker indicator tells us some useful information about a market, it's worth considering supplementary information from a secondary indicator to check what you're seeing. For example, you might want to use a trend-confirming indicator, such as a moving average, to double-check the state of the market, as in our example above. Indicators don't always look at the same information and different indicators can give you a different look at market data.
Naturally, the wider selection available to you, the better choice of indicator you can make. Though MetaTrader 4 comes with a decent choice of standard indicators, you can easily give yourself a wider suite of tools by downloading MetaTrader 4 Supreme Edition. MT4SE is a custom plug-in developed by industry professionals, that offers a cutting-edge selection of trading features.
The Forex DeMarker Indicator in Conclusion
As we have seen, the DeMarker indicator is a momentum oscillator with more than one trick up its sleeve. You can use the indicator to confirm if a market is in a trending or non-trending state. If you have identified a trending market, the indicator will confirm the overall directional bias. Most usefully of all, the indicator also gives us values for buying and selling pressure. With the help of these indications, we can use the DeMarker indicator to signpost potential temporary reversals in a price trend.
If you found this discussion interesting and that it provides you with a useful answer to the question of what the DeMarker indicator is, you might also find it useful to read our article on the Force Index Indicator.