The first input, Plot Time, is the time at which the average
for the day is to be calculated. It is defaulted to 5 minutes.
The second input, Delay,
is the time at which the vertical bar will appear on the chart. It is defaulted
to 60 minutes.
This indicator must be plotted on subgraph one, as
The following is an
excerpt from "Four Steps to Trading Success – Using Everyday Indicators
to Achieve Extraordinary Profits" by Dr. John Clayburg which will be
published during mid year 2001 by John Wiley and Sons.
Think about your day
trading activities for a moment.
The profits were
The losses were awful.
More winners would be
But, fewer losers can
truly turn your day trading into the profitable enterprise which you first
envisioned when you entered the world of the active day trader.
The often quoted trading
axiom, "Let your profits run and cut your losses short", is as
accurate and worthy of your attention as the day it was first written by someone
long ago. But now let’s add another concept to this basic idea of trading.
Imagine what your bottom
line could look like if you had an accurate method of reducing your number of
losses by even 15 – 20%.
One of the purposes of
this book is to teach you to significantly increase the number of winning trades
executed each trading day. Here is where we start this important process.
Trading only in the
direction of the dominant trend for the day can significantly reduce the number
of losing trades that are taken during the course of your busy trading day.
The Directional Day
Filter is designed to accomplish this exact purpose – define the major trend
of the day early enough in the trading day to make this determination useful for
the majority of the trading session.
Look at the intraday
price chart of any contract or security, concentrating on the early portion of
each trading day. Observe the occurrence of the highs and lows that are
registered during this early time frame. Regular observation of intraday price
charts will soon reveal the fact that, quite often, the high or the low of the
day is established early in the trading session, often within the first 60 to 90
minutes of the day. This basic fact of market behavior is the basis for the
operation of the Directional Day Filter.
It is here that market
psychology enters into the performance of this trading tool.
For a stock or commodity
to trade higher for the rest of the day there obviously must be more buyers than
sellers. As the trading public reacts to positive fundamental news concerning
the issue in question, interest rate movements, government reports, earnings
news, or the myriad of additional factors which make up the fundamental picture
which effects the price of a stock, a buying interest develops early in the day.
Buying activity in a stock or commodity soon attracts more interest on the buy
side as others become aware of the news and either enter new long positions or
rush to cover their short interests in the face of a rising market. And, yes,
technical traders such as ourselves enter on the buy side due to the technical
factors which identify a rising market.
Since the basic
fundamental news concerning a stock rarely changes through the trading day, the
same fundamental factors will continue to spur buying activity during the day.
The Directional Day
Filter measures this buying activity and predicts the basic trend of the day.
This filter is a highly
effective, yet simple routine that is used during the initial portion of the
trading day to define the major trend of the current day. Properly interpreted,
the Directional Day Filter can determine, with a high degree of accuracy, the
trend for the remaining portion of the trading day. After mastering the
interpretation of this simple concept, you will be able to accurately predict an
uptrending day, a downtrending day, or a sideways, trendless day.
As with many trading
indicators, their accurate interpretation is frequently as much of an art as it
is a science. It is only after careful, extensive observation and study that
most traders become familiar and comfortable with an indicator such as this to
the extent that they have the confidence necessary to use them in actual trading
situations. Carefully study the following pages, as this indicator can be a very
powerful tool to assist you in your intraday, and eventually, overnight trading.
We will first
concentrate on a detailed discussion of the construction and strict
interpretation of the Directional Day Filter. Following the section on the
basics of the tool we will include a considerable number of actual price charts
taken from real markets, going through extensive descriptions of the actual
application of this indicator. Careful study of these selected charts will begin
to give you an appreciation of the many different and varied ways this indicator
can be utilized in your trading. But it will only be with the close observation
of many, many days of intraday charts as they unfold during market hours using
this tool that you will gain the knowledge necessary to make full and proper use
of this unique indicator.
Trend of the Day
As mentioned above, this
tool is used to define the trend of the market in question for the remainder of
the trading session. The seasoned chart observer will agree that quite often the
high or low of the trading session will be established within the first hour of
the day. This trading aid attempts to determine whether the high or the low of
the day has been established early in the session. If the low is established
then we will expect any range expansion that will occur for the rest of the day
to be on the high side of the market. In other words, if we are certain that the
low of the day is in place, we will then expect a series of new highs to be
established as the trading session progresses. If, on the other hand, we can
determine with a reasonable degree of certainty that the high of the day has
been established by a given time, we should then see any range expansion develop
on the low side of the market with a series of new lows established for the
remainder of he day.
Thus our definition of
an uptrend for the rest of the day is a day in which the low is established for
the market early in the day and one or more new highs are made during the
remainder of the session.
definition of a downtrend as indicated by this trading tool is a day in which
the high of the day is established early and the rest of the day is featured by
the establishment of at least one new low for the day.
It is quite important to
understand this definition and keep it in mind as we move through the trading
examples in later chapters.
Why is this important?
One of the most basic
theories of trading is the concept of trading in the direction of the dominant
trend in the market. The old adage "the trend is your friend" should
never be forgotten by the serious trader. It is a concept vital to your
Trading with the trend
is important regardless of the time frame of your trading environment. It is
just as important for trading on a daily, weekly, monthly, or in our case, an
Working with many
traders over the years I have noticed one thing common to all beginning traders
- the attitude that they are smarter than the market and "just know"
that the top of the market has been made for the day and that "it’s just
got to go lower from here". There are a variety of trading tools and
attitudes that can create this false impression for many traders.
The usefulness of the
directional day filter is to keep the perspective of the day trader on the
bigger picture. Quite frequently, especially when working with extremely short
time frames, the active day trader will lose perspective of the entire day when
concentrating on the extremely narrow focus of perhaps only a few minutes.
The concept is quite
basic. If you have defined an uptrending day, you will take only the buy side of
the market, thereby trading with the trend of the day, which is higher. If you
have determined that the dominant trend is lower, you will trade only the short
side of the market, again in the direction of the dominant trend. If you have
determined that there is no dominant trend for the day, you can be confident in
taking trades on both sides of the market, understanding that there probably
will be no extended moves in any one direction for the remainder of the trading
This concept of trading
in the direction of the dominant trend is not only useful for entering trades.
It also finds important uses when the time comes to exit your trade.
indicators which we will use later in the book to define entry points for trades
will give both buy and sell signals throughout the course of any trading day.
During an uptrending day, the sell signals issued by our oscillator indicators
will not be used to establish new short positions, since these trades would be
taken opposite to the major trend of the day. Instead the sell signals can be
used as a criteria to be considered for the exiting of a long trade. Oppositely,
buy signals given on a downtrending day can be used as exit points for existing
a previous chapter dealing with day trading methods and philosophies mention was
made of a long term day trading strategy. This type of trade attempts to stay in
a trend for most of the day. Using the Directional Day Filter to get you in a
trade in the right direction for this long term transaction is an option
certainly worth considering.
How it works
The Directional Day
Filter is actually more of a chart reading tool than an indicator itself.
Although it can be programmed to automatically plot on your screen and give
actual trading alerts, it is not necessary to do so. A simple interpretation of
a chart pattern early in the day will give the trader all the information
necessary to determine the major trend of the day.
After five minutes of
the market day has passed, record the highest price which the market has reached
at this point in time. Also record the lowest price of the day at the same time.
Be sure to use only the day session data in your calculations. No overnight data
is to be included here. From the data you have recorded, an average price for
the first five minutes of the day can be calculated by adding the two recorded
prices and dividing by two. The resulting price is the critical price level
which you will use for the rest of the trading session to determine the trend of
The next critical chart
examination for the use of the Directional Day Filter comes after the market has
traded for one hour. It at this point that you will determine, with a high
degree of likelihood, the dominant trend for the remainder of the trading
The vertical bar placed
on the chart above identifies the first 60 minutes of trading for the day in
question. It is at this time, in most instances, that you will be making the
initial observation involving the Directional Day Filter. At this point it is
critical to determine the amount of market activity which has occurred both
above and below the line which marks the average of the first five minutes of
If there is
substantially greater activity above the average line than below the line at
this time of the session the odds are significantly in favor of the trend for
the rest of the day to be higher. Conversely, if there is more market activity
below the line than above there is a greater tendency for the market to trade
lower for the remainder of the trading session in question.
Additionally, it is
important to note the close of the bar that is present at the time the above
determination is made. In other words, if the determination of the amount of
activity is to be made 60 minutes into the trading day then pay close attention
to the close of the bar which marks this time on the chart. If the close of this
bar is significantly above our average line there is now additional evidence
that the remainder of the day will show a higher trend. If the close of this bar
is significantly below our average line then we have further likelihood of new
lows being made later in the session thereby producing a downtrend for the rest
of the day. Closes of this bar which lie relatively close to our average line
would tend to give the interpretation of the trend for the day as outlined by
this trading tool a more neutral flavor.
The measure of activity
to which I refer on these charts is defined as strictly the number of trades
which have occurred above or below our average line. This does not refer to the
number of closes, the number of highs, the number of lows, the number of
complete bars, etc. It is strictly an observation of the general amount of
trading activity which has occurred on either side of this critical average line
which we calculated earlier.
Although it is certainly
possible to calculate the number of trades above and below our average line and
keep a running total of these values as the trading day progresses, it is not
usually necessary to do so. Again, recall that many of these tools work as they
do because they are used extensively by the many people who trade these markets.
Most of these traders watch this activity and interpret the unfolding patterns
strictly by observation. Therefore it is also wise for you to make the same
Since this tool is
intended to be interpreted strictly by observation of the amount of activity
both above and below the line at a particular time in the trading day, there
will obviously be days and times at which there is no observable difference in
these two activity patterns. The trader will, on selected days, have difficulty
in determining if the activity above the line is greater than that below the
line, or vice versa. When you find yourself in this situation, there are two
routes of activity that you may pursue from this point forward.
The most frequent, and
usually the most accurate interpretation of this type of chart pattern will be
to classify the trend for the remainder of the trading session as a sideways
day, or one in which no definite trend is expected to develop as the trading day
progresses into the close of the day. On the days when a trendless day is
expected from the observation of the Directional Day Filter, the trader can have
equal confidence in taking trades from both a long and a short perspective.
Since the development of a dominant trend is not anticipated, those minor trends
that do appear are not expected to remain active for any substantial period of
time and can be projected to reverse after moving in any particular direction
for a relatively limited objective, both in time and price. Therefore both long
and short trades should have trading potential on these defined sideways days.
Secondly, one may wish
to once again observe the relative activity above and below the line at a point
a bit later in the day and re-assess the determination of the major trend of the
day at this point. This may be particularly true on certain days when the
trader, from a fundamental or technical point of view, feels a definite trend
should develop sometime during the trading session. Although delaying this
prediction is certainly acceptable, I would personally not extend this
observation point beyond 2.5 hours into the trading session. I would restrict
the determination to this time frame mainly due to the fact that the 60 minute
time frame has been shown by extensive research to be highly reliable. When you
do discover that a particular technical indicator is quite accurate when used in
a set manner it is often not wise to override the output of such a tool. Working
with many traders over the years, I have often heard the comment that "Had
I just followed my own trading rules I wouldn’t be in this much trouble with
my trading account".
By John F. Clayburg
JOHN WILEY & SONS, INC.