Relative Volatility Index (RVI)

1. Introduction

TheRelative Volatility Index (RVI) is a technical indicator designed to measure the direction and magnitude of volatility. Unlike other volatility indicators that focus solely on the level of price fluctuations (such as Bollinger Bands or ATR), the RVI incorporates the trend direction, making it a valuable tool for identifying potential trade opportunities.

Developed in 1993 by Donald Dorsey, the RVI is often used in combination with trend-following indicators to confirm signals. It resembles the Relative Strength Index (RSI) but instead of measuring price momentum, it focuses onvolatility direction.

2. Calculating the RVI

The RVI is calculated based on the standard deviation of price changes, smoothed over a predefined period. Here’s the step-by-step process:

1. Standard Deviation Calculation:

   • The indicator computes thestandard deviation (σ) of price over a selected period.
   • The standard deviation can be calculated using either thepopulation orsample method.

2. Directional Volatility Components:

   • If the closing price of the current bar is higher than the previous close, the volatility is consideredpositive.
   • If the closing price is lower, the volatility isnegative.

3. Smoothing the RVI:

   • The RVI is obtained by smoothing the ratio of positive volatility to total volatility over a set period.

The formula for the RVI is:

RVI=100×Smoothed Upward Volatility+Smoothed Downward VolatilitySmoothed Upward Volatility​

Values range from 0 to 100, where higher values indicate stronger upward volatility, and lower values signal downward volatility.

3. Configuration and Parameters

The RVI can be customized using several key parameters:

• Standard Deviation Length (stdevLength): Defines the period for the standard deviation calculation (default: 10).
• Smoothing Length (smoothLength): Defines the period used to smooth the RVI calculation (default: 14).
• Overbought Level (obLevel): A predefined level where volatility suggests an overbought market (default: 80).
• Oversold Level (osLevel): A predefined level where volatility suggests an oversold market (default: 20).
• Moving Average Length (maLengthInput): Optional smoothing with a moving average (default: 14).
• Bollinger Bands Activation (useBB): Allows the addition of Bollinger Bands around the RVI.

4. Interpretation and Trading Strategies

How to Use the RVI in Trading?

The RVI is commonly used to confirm trend strength and identify potential reversals:

• Trend Confirmation:

  • A rising RVI suggests increasing bullish volatility, confirming an uptrend.
  • A falling RVI suggests increasing bearish volatility, confirming a downtrend.

• Overbought/Oversold Signals:

  • If the RVI crosses above80, it may indicate an overbought condition.
  • If the RVI drops below20, it may signal an oversold condition.

• Divergences:

  • If price makes anew high, but the RVI fails to do so, abearish divergence may indicate weakening momentum.
  • If price makes anew low, but the RVI remains stable or rises, abullish divergence may signal a potential reversal.

Strategy Ideas Using the RVI

1. RVI + Moving Average:

   • Use amoving average of the RVI to filter out noise.
   • Buy when the RVI crosses above its moving average.
   • Sell when the RVI crosses below its moving average.

2. RVI + Bollinger Bands:

   • If the RVI moves outside theupper Bollinger Band, it signals extreme bullish volatility.
   • If the RVI moves outside thelower Bollinger Band, it signals extreme bearish volatility.

3. Breakout Confirmation:

   • Highlight breakouts by coloring the area where the RVI crosses key levels.
   • If RVI crosses above 80and price breaks resistance, it confirms strong bullish momentum.

5. Implementation in ProRealTime

The RVI can be programmed inProRealTime’s ProBuilder language, ensuring flexibility in customization. The implementation follows these key steps:

1. Compute the standard deviation using the selected calculation method.
2. Determine directional volatility (upward or downward).
3. Apply smoothing to refine the final RVI value.
4. Optionally, add a moving average andBollinger Bands for additional analysis.
5. Visualize the indicator with color-coded levels to highlight overbought and oversold zones.

The ProBuilder code follows these principles and allows easy parameter adjustments.

6. Conclusion

TheRelative Volatility Index (RVI) is a powerful tool that provides insight into thedirection of volatility, helping traders confirm trends and identify reversals. While it should not be used in isolation, combining it withmoving averages, Bollinger Bands, or other momentum indicators can enhance its effectiveness.

Share this

Embed