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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.
Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.
