Relative Volatility Index (RVI)

The Relative Volatility Index was created by Donald Dorsey and first presented in the June 1993 issue of Technical Analysis of Stocks and Commodities – The Relative Volatility Index.  He noticed that most technical analysts look for confirmation from several indicators before initiating a trade in order to reduce the occurrence of false signals.  This is a logical approach however many indicators are simply variations on the same calculation.  Dorsey described this as “not unlike taking two wind direction readings rather than reading the wind direction and barometric pressure to predict tomorrow’s weather”.

Because most indicators measure price change, Dorsey developed the RVI as a confirming indicator that measures the direction of volatility.  It is almost identical to the Relative Strength Index (RSI) but uses the standard deviation of high and low prices.

“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.”

How To Calculate the Relative Volatility Index

RVI = 100 * U / (U + D)

Where:

U = Wilder’s Smoothing,N of USD

D = Wilder’s Smoothing,N of DSD

USD = If close > close(1) then SD,S else 0

DSD = If close < close(1) then SD,S else 0

S = User selected period for the Standard Deviation of the close (Dorsey suggested 10).

N = User selected smoothing period (Dorsey suggested 14)

(Instead of using Wilder’s Smoothing we use an EMA with a period of (N*2)-1 which produces the same result but is faster to calculate.)

Here is an example of a RVI with an “S” and “N” of 3:

RVI Formula

Relative Volatility Index Excel File

I have put together an Excel Spreadsheet containing the Relative Volatility Index and made it available for FREE download.  It contains a ‘basic’ version displaying the example above and a ‘fancy’ one that will automatically adjust to the length you specify.  Find it at the following link near the bottom of the page under Downloads – Technical Indicators: Relative Volatility Index (RVI)


Relative Volatility Index Example

RVI Example

How to use the Relative Volatility Index

The Relative Volatility Index measures the direction and magnitude of volatility.  High readings indicate the market is moving up strongly, low readings indicate a strong bearish move and readings round 50 indicate a lack of direction.  In this way the RVI can be used to measure the strength or lack of a trend.  However like the RSI, extreme readings often warn of a reversal.

Here are the buy and sell rules that Dorsey developed for the RVI.  Keep in mind that he intended this as a confirming indicator not a stand alone system:

  • Buy only  if RVI > 50
  • Sell short only if RVI < 50
  • If you miss the first RVI buy signal buy when RVI > 60
  • If you miss the first RVI Sell signal sell when RVI < 40
  • Close a long position when the RVI falls below 40
  • Close a short position when the RVI rises above 60

In the September 1995 issue of Technical Analysis of Stocks and Commodities, Dorsey wrote a follow up article – Refining the Relative Volatility Index.  Here he presented the idea of using the average of two RVIs; one of high prices and one of low prices and then smoothing the result with a 20 day Linear Regression Indicator.  He called the new version “Inertia”.

“A trend is simply the outward result of inertia.  Once a market starts to move, it takes significantly more energy for it to change direction than for it to continue along the same path.”

 

In Physics Inertia is described as the amount of resistance that an object requires for a change in velocity.  To get a reading of Inertia requires a measure of mass and direction.  In the stock market there are many different ways (each of varying effectiveness) to measure direction but what about mass?

Because volatility reveals the markets propensity to make various sized movements regardless of direction, Dorsey saw it as a possible measure for mass.  If his theory is correct then the RVI should be a particularly useful trend indicator.

His modified version of the Relative Volatility Index or “Inertia” can be used as a long term trend indicator where readings above 50 indicate positive Inertia and readings below 50 indicate negative Inertia or a bearish trend.


Test Results

As part of the ‘Technical Indicator Fight for Supremacy‘ We have tested/will test the Relative Volatility Index as a component in several technical indicators:

We will also be testing its stand alone buy and sell signals and if they are good then we see how it performs as a confirming indicator.