Relative Volatility Index

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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 behaviour... 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.”