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Relative
Volatility Index
Description
The
Relative Volatility Index (RVI) was developed by
Donald Dorsey. It
was originally introduced in the June 1993 issue
of Technical Analysis of Stocks and Commodities
magazine (TASC).
A revision to the indicator was covered in
the September 1995 issue.
The
RVI is used to measure the direction of volatility. The
calculation is identical
to the Relative
Strength Index (RSI) except that the RVI measures
the standard deviation of daily price changes rather
than absolute price changes.
Interpretation
When
developing the RVI, Dorsey was searching for a
confirming indicator to use with traditional
trend-following indicators (such as a dual moving
average crossover system).
He found that using a momentum-based
indicator to confirm another “repackaged”
momentum-based indicator is usually ineffective.
Dorsey
made this clear in the June 1993 TASC article:
“Technicians
are tempted to use one set of indicators to
confirm another.
We may decide to use the MACD to confirm a
signal in Stochastic... Logic tells us that this
form of diversification will enhance results, but
too often the confirming indicator is just the
original trading indicator repackaged, each using
a theory similar to the other to measure market
behavior... Every trader should understand the
indicators being applied to the markets to avoid
duplicating information.”
When
testing the profitability of a basic moving
average crossover system, Dorsey found that the
results could be significantly enhanced by
applying the following RVI rules for confirmation.
Similar rules are likely to be effective
for other momentum or trend following indicators.
-
Only
act on buy signals when RVI > 50.
-
Only
act on sell signals when RVI < 50.
-
If
a buy signal is ignored, enter long if RVI
> 60.
-
If
a sell signal is ignored, enter short if RVI
< 40.
-
Close
a long position if RVI falls below 40.
-
Close
a short position if RVI rises above 60.
Because
the RVI measures a different set of market
dynamics than other indicators, it is often
superior as a confirming indicator.
As Dorsey states:
“There
is no reason to expect the RVI to perform any better or
worse than the RSI as an indicator in its own right. The
RVI’s advantage is as a confirming indicator because
it provides a level of diversification missing in the
RSI.” |
