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How does the Demand Index indicator work

Demand Index indicator: What is it, how does it work, and how to use it


Hello dear friends. It is likely that everyone knows that Forex is the most attractive and promising financial market in the world. To succeed in such markets and gain financial freedom, it takes time and effort. In order to understand the financial market well, we must definitely learn the fundamentals of the market, technical analysis, fundamental analysis, and basic economic concepts. When trading, we frequently use technical indicators, which are part of technical analysis. Indicators provide us with exceptional clues to predict price movements, identify trends, and determine overbought or oversold levels. One of these technical indicators that we will now discuss is the Demand Index (DI) indicator.

What is the Demand Index indicator?

The Demand Index indicator was invented by James Sibbet. This indicator is designed to measure price momentum and the balance between supply and demand. J. Sibbet introduced the Demand Index in 1981, and it has since become a tool mostly used, especially in stock and futures markets. Besides that, we can use the Demand Index indicator to measure the demand for a currency pair. The Demand Index shows how demand for a commodity or service changes over time. For example, the index can calculate the ratio of demand for a specific period compared to a base year. If the demand index for a commodity or service is increasing, it may be expected that the demand for that commodity or service is also increasing. The Demand Index combines price momentum and volume effects, providing us with a more accurate and comprehensive perspective to support our trading decisions.

Calculation of the Demand Index indicator

The Demand Index is used to show how price movement relates to volume. A positive Demand Index indicates that price increases are supported by volume, while a negative Demand Index indicates that price declines are supported by volume. The main formula used to calculate the Demand Index is as follows:

   Demand Index = Price Change / Volume

In this formula, "Price Change" represents the difference in closing prices from one period to another, and "Volume" represents the daily trading volume during the same period. When calculating Price Change, the first step is to calculate daily price changes, typically done by taking the difference between the closing price of the current period and the closing price of the previous period. Often, this calculation is expressed using the formula (Price Change = Current Closing Price - Previous Closing Price). After that, we calculate the daily trading volume during the same period. Trading volume represents the total amount of trading that occurred during that period.

Components of the Demand Index indicator

The structure of the indicator is simple and is usually represented as a line chart. Here are the components of the Demand Index:

Demand Index Line. The Demand Index is plotted as a line chart. This line shows the calculated Demand Index values over time. We use Demand Index values to interpret the relationship between price movements and volume.

Zero Line. The Demand Index usually fluctuates around a zero line. Positive Demand Index values are located above the zero line, while negative values are below it. This indicates the direction of price movements and which direction is stronger.

The use of the Demand Index (DI) indicator in trading

The Demand Index indicator is one of the technical analysis tools that helps identify market trends and possible reversal points. When trading in financial markets, we can use this indicator to capture buy and sell signals. When the Demand Index line (the blue line in the picture below) crosses the zero line (the pink line in the picture below), it may signify a change in the market trend. The transition from negative to positive, meaning the blue line crossing above the pink line, would trigger a Buy order. This indicates the beginning of an uptrend or a weakening of a downtrend, and it could also signal a temporary pullback in a downtrend. On the contrary, a transition from positive to negative can signal that an uptrend is weakening, reversing, or experiencing a pullback. This is the time to enter a Sell order. Take a look at the example on the USD/CAD chart below:

Demand Index indicator chart showing buy and sell signals
Trading with DI in the USD/CAD chart

Like other technical indicators, we can trade using the Demand Index indicator by identifying divergences between the price chart and the indicator. I have previously discussed how to trade with divergence types in my previous article. If you wish, you can review 'Divergences' here. Here is another example of a divergence trade on the 4-hour EUR/CAD chart:

Demand Index indicator used to identify divergences and trade them
Divergence trading with DI in the EUR/CAD chart

Remember that while technical analysis indicators can assist in predicting market movements, they may not always provide precise results. Since market conditions are variable, caution should be exercised and risk management strategies should be implemented when making buying and selling decisions. No indicator, including the Demand Index indicator, can create a trading strategy on its own. It should always be used in combination with other indicators and considerations of fundamental analysis.

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