In addition to using the Simple Moving Average (SMA), it uses a smoothing co-efficient to determine the strength of the trend. The SMA tells the user about the current trend. Typically, when the price is above SMA the trend is considered bullish, and when it is below the SMA it is considered bearish. However, such a general rule of thumb is not useful in real trading world because of lag which causes delayed trade entries and exits.
Therefore, the iCompass indicator uses recent range high, low and the median price to identify the strength of the trend. In the first step, the SMA of the recent MA_PERIOD candles is computed. Then, the Highest High and the Lowest Low of recent MA_PERIOD candles is calculated. This provides us with a trading range. Next, we calculate the smoothing co-efficent based on the current median price, and the trading range. When this co-efficient is low it implies price is at the lower end of the trading range and therefore bearish. The opposite is true for a bearish trend. Finally, we calculate the log-normal value of this co-efficient, which is used to identify the bullish and bearish trend of the iCompass. When this value is below zero it is considered a bearish trend and the indicator is colored RED. Likewise, if the log-normal co-efficient is above zero, the indicator is colored BLUE signifying a bullish trend.
BUY / EXIT SHORT - Enter LONG (or exit SHORT) when the iCompass indicator turns BLUE from RED and is rising. Do not enter LONG trade if the indicator turns BLUE from RED but is still falling. However, SHORT positions can be exited under such conditions. The stop-loss can be set to the nearest Swing Low. Traders are advised to employ a trailing stop when the trade turns profitable.
SHORT / EXIT LONG - Enter SHORT (or exit LONG) when the iCompass indicator turns RED from BLUE and is falling. Do not enter SHORT trade if the indicator turns RED from BLUE but is still rising. However, LONG positions can be exited under such conditions. The stop-loss can be set to the nearest Swing High. Traders are advised to employ a trailing stop when the trade turns profitable.