Spot Price Reversals With the DeMarker Indicator
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This article will provide traders with everything they need to know about the DeMarker trading indicator. It will cover: how to find price reversals with the DeMarker indicator, how to use the DeMarker indicator in MetaTrader 4, a trading strategy you can use with the DeMarker indicator, and more!
What is the DeMarker Indicator?
The DeMarker indicator (also known simply as 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 available 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 focuses 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 take a look at how to use 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'1, as you can see from the image below:
Source: MetaTrader 4 - Setting the parameters for the DeMarker indicator in MT4
When you double-click on DeMarker, you are presented with the 'Parameters' window (as shown above). The key parameter value that you can set is the 'Period', which has a default value of 14 in MT4. In the image below, we've added the DeMarker indicator to an hourly USD/CHF chart:
Source: MetaTrader 4 - price data from Admiral Markets - hourly USD/CHF chart - Data Range: 22 August, 2017 to 29 August, 2017 - Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
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
The DeMarker trading strategy is basically a contrarian approach, seeking reversals in the 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 that there is buying pressure. 'Strongly oversold' tells us that there is selling pressure. So how do we use the overbought and oversold indicators 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 provides us with insights as to whether the market is in a trend or not. If a market remains for an extended period in extreme overbought levels, it confirms that 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 that levels above 70 are indicative of the market being in extreme overbought territory, and below 30 indicates that it is in extreme oversold territory.
As long as the indicator remains in these areas, we should be wary in terms of taking a position, as directional pressure appears to remain in place. Ideally, we are aiming to buy into temporary drops in the price within an overall uptrend, or to 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. Take a look at the daily USD/CHF chart below:
Source: MetaTrader 4 - price data from Admiral Markets - daily USD/CHF chart - Data Range: 15 March, 2017 to 30 August, 2017 - Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
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 suggests 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 that there is a temporary easing in the selling pressure.
As soon as the indicator rises above 0.3, we buy the market, provided that we can get in below 0.5. Bear in mind that you are looking for temporary reversals, and you 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.
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 best 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 to 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 give 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 might want to consider a lower boundary for overbought, and a higher one for oversold. For example, if you are using a value of 18 for the period, you might want to consider 40 as oversold, and 60 for overbought.
Though the DeMarker indicator provides us with 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, like in our example provided 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 the 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 provide yourself with a wider suite of tools by downloading MetaTrader Supreme Edition. MTSE is a custom plugin for MetaTrader 4 and MetaTrader 5, developed by industry professionals, that offers a cutting-edge selection of trading features.
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 within a price trend.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.