V.11:6 (253-256): The Relative Volatility Index by Donald Dorsey

The Relative Volatility Index by Donald Dorsey

This author modifies the basic relative strength index to measure volatility instead of daily net price change to generate trading signals.

Technicians are often tempted to use one set of indicators to confirm another. We may decide to use the moving average convergence/divergence (Macd) to confirm a signal in stochastics or use momentum readings to confirm moving average models. Logic tells us that this form of diversification of indicators 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. It is not unlike taking two wind direction readings rather than reading the wind direction and barometric pressure to predict tomorrow's weather. Thus, the enhancement we sought through diversification results in loss, and we are left wondering why our indicators don't seem to perform much better. Every trader should understand the indicators being applied to the markets to avoid duplicating information.

RESEARCH AND COMBINATION

I have been researching the combination of two indicators, the first a timing indicator and the second confirming the first. The first indicator is a dual moving average crossover and is confirmed by a measure of directional volatility. I call the directional volatility measure the relative volatility index (RVI). The RVI (see sidebar, "Relative volatility index") is simply the relative strength index (RSI) with the standard deviation over the past 10 days used in place of daily price change. Because most indicators use price change for their calculations, we need a confirming indicator that uses a different measurement to interpret market strength. The RVI measures the direction of volatility on a scale of zero to 100.