Vertical Horizontal Filter

Introduction

Vertical Horizontal Filter was initiated by Adam White. It was first published in a magazine called “Issues of Futures” in August, 1991. The Vertical Horizontal Filter (VHF) is a very common Indicator used by traders to find out the Phase of a Price Trend. Normally, a price trend can be in a Trending Phase or a Congestion Phase/Choppy Movement Phase. Adam White created this particular Technical Indicator to determine whether prices are trending in a particular direction or are they going through a transitional period. He used it to measure the range of Futures available in the market.

This tool is used prior to any other Technical Indicator. Reason behind it is that, it helps in determining the phase a stock is going through. Afterwards, various Trend Indicators could be used to determine Direction, Speed and Volatility of Stocks. Similar in style to ADX, VHF is used to decide whether a trend is in situ or the trend is going through a non-trending transitional period commonly known as Congestion Phase. VHF is commonly used by traders to get rid of the limitations of Lagging Indicators like Moving Averages and MACD which can victimize Traders if the market is non-trending.

Adam used comparison of an interval’s rate-of-change to their range from high price to low price during a specified interval of time. Trend Indicators like MACD and Moving Averages tend to fail in Congestion Phase.  RSI and many other Oscillators have an exaggerated response to pull backs during Trending in Markets after a congestion phase. Vertical Horizontal Filter removes this defect by using Trendiness of a market. Whenever, there is an increase in the VHF, it indicates an upward or downward trend. On the Contrary, when VHF falls, it is indication of a Ranging Market.

Calculation

In order to calculate the VHF Indicator, all you have to do is to determine the Highest Closing Price and Lowest Closing Price over a Specified Interval. The predetermined Interval is usually comprised of 28 days.

HCP = Highest closing price in n-periods

LCP = Lowest closing price in n-periods

The very next step in calculation of Indicator is to determine the range i.e. difference of HCP and LCP. After taking absolute value of the difference, place it in the numerator of Indicator’s Formula.

Numerator = Absolute value of ( HCP - LCP )

In order to calculate the upper portion, add up the absolute value of difference of each days closing’s price from the previous day’s closing for the whole Interval period i.e. 28 days. To determine the denominator, sum the absolute value of the difference between each day's price and the previous day's price over the specified time periods.

Denominator = ∑ Absolute value of ( Close_j - Close_j-1 )

Where the range of 'J' is from '1' to 'n'.

The Answer of above formula is placed as the denominator of the Formula for VHF like this:

VHF = Numerator / Denominator 

Specifications

One of the Prominent Dilemma of 21st Century is the determination of trending or non-trending prices in the market. Trend-Following Indicators primarily MACD and Moving Averages which are an excellent solution for trend following, tend to generate multiple conflicting trade signals during Congestion Phase of Market. Contrarily, Oscillators are handy in trading range, but often close positions untimely during trending markets. Trendiness of Prices is used by VHF Indicator to assist traders in choosing a right technical indicator in a particular situation.

In order to calculate High and Low Prices, Adam used 28 days data. Later on, he went to use 18 day data smoothed with a six day moving average to study the Indicator. There are three common ways to study VHF Indicator:

1. VHF Outcome is a significant indicator of the trend prevailing in the market. As the value of VHF moves upward, the degree of trending moves upward as well and vice versa. This means that trend following indicators can be used to predict future trends.
2. Direction of VHF Indicator can be used to predict a Congestion Phase. A rising VHF Figure indicates a trending market whereas a falling VHF Figure indicates a Congestion Phase Developing.
3. VHF Indicator can be used in situations contrary to Typical Trend Followers. VHF indicates an approaching congestion period when the VHF Value goes too high. Similarly, extremely low VHF Values indicate an upcoming trending period in the market.

So, the traders can rely on the values of VHF. If the values of VHF are high, trend would be sharp. Contrarily, if the VHF values are low, trend would be stable and within a range. Similarly, high VHF values indicate a trend reversal approaching the market.

Advantages of Vertical Horizontal Filter

1. Trend Following Indicators could be costly if a Stock is going through a Congestion Period. VHF Indicators helps in determining the Phase of the Market.
2. Oscillators including RSI are handy when the market is ranging, but often signal premature decisions when prices pull back.
3. VHF Indicator determines the current as well as upcoming trend in the market. If the VHF Values have gone too high, it means a trend reversal. Similarly, if a price is too low, it shows an approaching congestion period.

Disadvantages of Vertical Horizontal Filter

1. Vertical Horizontal Filter doesn’t generate trade signals i.e. buy signals, sell signals or buy and hold signals.
2. Vertical Horizontal Filter doesn’t provide a clear indication to whether a Trend Follower should be used or an Oscillator.