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Random
Walk Index
Description
In
an effort to find an indicator that overcomes the
effects of a fixed look-back period and the
drawbacks of traditional smoothing methods,
Michael Poulos developed the Random Walk Index.
The Random Walk Index is based on the basic
geometric concept that the shortest distance
between two points is a straight line.
The further prices stray from a straight
line during a move between two points in time, the
less efficient the movement.
Interpretation
Mr.
Poulos found significant evidence during his
research that the "dividing line"
between short- and long-term time frames for most
futures and stocks is right around eight to 10
days. Therefore,
he feels an effective trading system using the RWI
can be devised using two different time frames—a
short-term RWI (two to seven periods) for the
market's frantic, random side and a long-term RWI
(eight to 64 periods) for the market's steady,
trending side.
Peaks
in the short-term RWI of highs tend to coincide
with price peaks. Peaks
in the short-term RWI of lows tend to coincide
with price troughs.
Readings
of the long-term RWI of highs above 1.0 provides a
good indication of a sustainable up trend.
Readings of the long-term RWI of lows above
1.0 provide a good indication of a sustainable
downtrend.
Therefore
Mr. Poulus feels that an effective trading system
could be built that opens trades (after short-term
pull-backs against the direction of the long-term
trend) using the following guidelines:
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Enter
long (or close short) when the long-term RWI
of the highs is greater than 1.0, and the
short-term RWI of lows peaks above 1.0.
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Enter
short (or close long) when the long-term RWI
of the lows is greater than 1.0, and the
short-term RWI of highs peaks above 1.0.
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