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The damping index, created by Curtis McKallip Jr., is a technical analysis indicator that indentifies bars where the highs and lows are getting close and closer.
In order to do so, it calculates a simple moving average of the difference between the high and low prices using a period of 5 bars. Let us call X the result of this calculation. It then divides the value of X one bar ago by the value of X six bars ago to produce the damping index.
As you can see from the above calculation, a high damping index value means that the value of X six bars ago is higher than the value of X one bar ago, and this means that the difference between the high price and low price is becoming lower. The security price is reaching equilibrium. A low damping index value means that the difference between the high and low prices is increasing.
In the above example, I have used a period of six bars to calculate to damping index, but you can choose a custom period that you can enter as a parameter to the damping index function I have implemented. The function name is "damping".
With some backtesting and analysis I was able to come up with an interesting trading rule:
(damping ( 6 ) >= 3 * sma ( damping ( 6 ) , 10 ) && perf ( close , 10 ) < - 14)
The rule should be applied to short stocks. When using a 10-bar stop, it produced 1133 trades with an average gain of 0.279% per bar and with a 62.22% percent winners.
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