The Relative Volatility Index (RVI) is an often overlooked yet powerful technical indicator in the world of trading. Developed by Donald Dorsey, the RVI measures the direction of market volatility rather than price movement. By focusing on volatility, the RVI provides traders with an alternative way to analyze market conditions and make informed decisions. This article delves into the best RVI trading strategies, helping traders harness this tool to enhance their trading performance.
What is Relative Volatility Index (RVI)
Before diving into specific strategies, it's essential to understand what the RVI is and how it works. Unlike the Relative Strength Index (RSI), which measures price momentum, the RVI measures the standard deviation of price changes over a specified period. The RVI oscillates between 0 and 100, with values above 50 indicating bullish volatility and values below 50 indicating bearish volatility.
Why Use the RVI?
The RVI's primary strength lies in its ability to account for market volatility, which often precedes significant price movements. By focusing on the "pulse" of the market rather than just price levels, traders can:
⦁ Identify overbought and oversold conditions.
⦁ Confirm trends and reversals.
⦁ Spot divergences that indicate potential turning points.
Best RVI Trading Strategies
1. Overbought and Oversold Conditions
Similar to the RSI, the RVI can help traders identify overbought and oversold conditions. While the default values above 80 are considered overbought and values below 20 as oversold.
⦁ When the RVI crosses above 80, it indicates overbought conditions.
⦁ Conversely, when the RVI falls below 20, it indicates oversold conditions.
Example: If the RVI of a stock climbs to 85, you might prepare for a short trade, especially if other indicators like candlestick patterns confirm a reversal.
Tips: Combine the RVI with volume indicators to validate overbought or oversold signals.
2. Divergence Trading
Divergence occurs when the price action of an instrument moves in the opposite direction of the RVI. This divergence is often followed by a trend reversal and can be a reliable signal for traders.
Bullish Divergence: The asset price forms lower lows, but the RVI forms higher lows. This indicates weakening bearish momentum and a potential upward reversal.
Bearish Divergence: The asset price forms higher highs, but the RVI forms lower highs. This suggests weakening bullish momentum and a potential downward reversal.
How to Trade RVI Divergence
Identify divergence by comparing the RVI's movements to price action.
Wait for confirmation, such as a breakout or reversal candlestick pattern.
Enter the trade in the direction of the anticipated reversal.
Example: Suppose the price of gold forms higher highs, but the RVI forms lower highs. This bearish divergence may indicate that gold is losing bullish momentum, making it an excellent opportunity for a short trade.
Tips: Combine divergence signals with support and resistance levels to increase accuracy.
3. RVI and Moving Average Crossover
The combination of the RVI with a moving average (MA) can enhance your ability to identify trends and potential entry points. This strategy involves using a moving average of the RVI itself to confirm trend changes.
How to Trade RVI and MA Crossover
Apply a moving average (e.g., 9-period) to the RVI.
When the RVI crosses above its MA, it signals bullish momentum.
When the RVI crosses below its MA, it signals bearish momentum.
Example: If the RVI crosses above its 9-period MA, it might indicate a good time to enter a long trade, especially if other indicators confirm bullish sentiment.
Tips: Use higher timeframes for more reliable signals, as lower timeframes can produce noise. And also wait for a restest of RVI towards MA for an entry.
4. Trend Confirmation
The RVI can act as a trend confirmation tool when used alongside other trend-following indicators such as Moving Averages, the Average Directional Index (ADX), or the MACD.
In an uptrend, confirm bullish momentum when the RVI stays consistently above 50.
In a downtrend, confirm bearish momentum when the RVI remains below 50.
Example: In a trending market, if the RVI stays above 50 and forms higher lows, it's a sign to stay in long positions.
Tips: Avoid using this strategy in choppy or sideways markets, as it's most effective in trending environments.
5. Breakout Strategy
Volatility often precedes breakouts, making the RVI an excellent tool for predicting such events. When the RVI shows a significant spike, it may indicate that the market is preparing for a breakout.
How to Trade:
Monitor the RVI for sudden increases in volatility.
Identify key support and resistance levels.
You may enter the trade when the price breaks through these levels, accompanied by high RVI values.
Example: If the RVI spikes and the price of a stock breaks above a strong resistance level, it's a good signal to go long.
Tips: Use stop-loss orders to manage risk, as breakouts can sometimes lead to false signals.
6. RVI and Multi-Timeframe Analysis
Multi-timeframe analysis involves examining the RVI across different timeframes to have a broader perspective of market conditions. This approach can help traders avoid false signals and align their trades with the prevailing trend.
How to Trade:
Use a higher timeframe (e.g., daily) to identify the primary trend.
Use a lower timeframe (e.g., 1-hour) to find precise entry and exit points.
Align your trades with the higher timeframe's RVI signals.
Example: If the daily RVI shows bullish momentum, but the hourly RVI dips below 20, it could present a buying opportunity within the larger uptrend.
Tips: Always prioritize the higher timeframe's trend direction to avoid countertrend trades.
7. Pairing RVI with Other Indicators
The RVI works best when used in conjunction with complementary indicators. For example:
RSI: Combine the RVI's volatility focus with the RSI's momentum analysis for comprehensive insights.
Bollinger Bands: Use Bollinger Bands to identify overbought/oversold conditions alongside RVI signals.
Volume Indicators: Validate RVI signals with volume spikes to confirm market activity.
How to Trade
Look for confluence between RVI and other indicators.
Use this confluence as confirmation before entering a trade.
Example: If the RVI indicates bullish momentum and the RSI shows an oversold condition, it's a strong buy signal.
Tips: To avoid analysis paralysis, you should avoid overloading your chart with too many indicators.
Final Thoughts
The Relative Volatility Index is a versatile tool that offers a unique knowledge of market volatility and momentum. By incorporating the RVI into your trading toolkit and combining it with other indicators, you can develop robust strategies that align with your trading style.
While the RVI is a valuable indicator, it's not foolproof. Always use proper risk management, such as stop-loss orders or correct sizing and diversifying your trades. Practice these RVI trading strategies in a demo account before using them on live accounts, and remember that no single indicator guarantees success.
We have two strategies based on divergence patterns:
FAQ
Q: Am I free to use this strategy however I want?
A: Sure! But we're happy if you refer to our website and keep the creator's name in the code.
Q: I'm using another platform, can you write the code in another language?
A: No, sorry. We might add code in more languages later to the website, but until then, we recommend you try ChatGPT or something similar to help you rewrite it.
Q: Why does my backtest look different when I run the code?
A: The strategy might give different backtest results for several reasons, like added spread or fees, the wrong time-zone settings, or that you're using another type of contract/instrument type.
Q: Will I make money if I run this strategy live?
A: We don't know. We're not financial advisors, we're just traders sharing our ideas.