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Relative Volatility Index (RVI)

What is the Relative Volatility Index?

The Relative Volatility Index (RVI) is an oscillating volatility indicator that was developed by Donald Dorsey to indicate the direction of volatility. It is similar to the Relative Strength Index (RSI), except that it measures the standard deviation of price changes over a look-back period rather than the absolute price changes. The RVI is plotted in a range from 0 to 100 with a centerline at 50. RVI values above 50 indicate that the volatility is to the upside, while values below 50 indicate that the direction of volatility is to the downside. Extreme RVI values of above 80 and below 20 are generally considered unsustainable and warn of a potential price reversal.

The RVI indicator does not generate buy or sell signals on its own and, thus, cannot be used as a standalone indicator. The RVI can, however, be used as a tool to confirm the signals generated by other technical indicators, such as Moving Average (MA) crossover signals.

The Relative Volatility Index should not be confused with the Relative Vigor Index, which uses that same abbreviation but is a momentum indicator rather than a volatility indicator.

How to calculate the RVI Indicator?

The RVI is calculated in a similar way as the RSI but using standard deviation of high and low prices rather than the absolute change in price. The RVI, however, also includes a signal line that is a simple moving average (SMA) of the RVI itself.

Thus, the first two steps in the calculation of the RVI is similar to that of the RSI: first, the Relative Volatility (RV) over the look-back period being calculated first by using standard deviation of the advances and the standard deviation of the losses. The formula is as follows:

RV = Standard Deviation of Up Periods ÷ Standard Deviation of Down Periods

Here the standard deviation is calculated over the look-back period.

The second step binds the RV to a range of 0 to 100 and produces the RVI. The formula for the second step is as follows:

RVI = 100 − ( 100 ÷ ( 1 − RV ) )

Finally, the signal line, which is a simple moving average (SMA) of the RVI itself, is added.

Signal Line = SMA_n( RVI )

where n is the look-back period for the SMA. The default look-back period is 10.

How to trade with the RVI Indicator?

The RVI was designed not as a standalone indicator, but as a tool to provide confirmation of trade signals generated by other technical indicators. This is the main purpose of the RVI. However, with the addition of a signal line, the RVI can also be used to generate potential entry and exit signals.

Trade Confirmation

The centerline (50) is key to confirming the direction of volatility. When the RVI is above 50 it indicates that the volatility is to the upside, and when it is below 50, it indicates that the direction of volatility is to the downside. Thus, when the RVI is above 50, it confirms a potential buy signal; and when it is below 50, it confirms a potential sell signal.

Overbought and Oversold Conditions

The RVI indicates overbought conditions when it is above the 80 line. This suggests that the price may have risen too far too fast and may be due for a pullback or a reversal, and would warn that further upside is limited. Thus, a trader with an open long (buy) position may want to consider taking profits or tightening their stop loss when the RVI is above the 80 line. In addition, traders could start looking for potential short (sell) opportunities.

Conversely, when the RVI is below the 20 line, it indicates oversold conditions, suggesting that the price may have fallen too far too fast and may be due for a bounce or a reversal. Here, further price declines could be limited, necessitating traders with an open short (sell) position to consider taking profits or tightening their stop loss, and suggesting that traders could rt looking for potential long (buy) opportunities.

Signal Line Crossovers

The addition of a signal line to RVI can also be used to generate potential trade entry signals, when the RVI crosses up over the signal line. This crossover indicates that volatility is shifting upwards, which could potentially lead to an increase in price. This could be taken as a potential buy signal but the signal should be confirmed by other technical indicators or technical analysis techniques. Conversely, the RVI crosses down over the signal line. This crossover indicates that volatility is shifting downwards, which could potentially lead to a drop in prices. This could be taken as a potential sell signal but, again, the signal should be confirmed by other technical indicators or technical analysis techniques.

Divergences

Divergences can also be applied to the RVI. A positive divergence below 20 would increase the probability of a signal based on a move above 20, and a negative divergence above 80 would increase the probability of a signal based on a move back below 80.

Donald Dorsey also state that: "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."

Advantages and Disadvantages of the RVI Indicator

RVI Frequently Asked Questions

Can the RVI be used with other technical indicators?

Yes, the RVI was designed to confirm signals from other technical indicators.

Can the RVI be used for day-treading?

Yes, the RVI can be used on any timeframe, including the timeframes used in day-trading.

Can the RVI be used to trade forex?

The RVI can be used on any type of financial market, including forex, stocks, commodities, indices, and cryptocurrencies.

What does a high RVI value indicate?

A high RVI value of more than 50 is a bullish signal that indicates that volatility has increased to the upside. However, the area above the 80 line is overbought territory, which calls for caution.

What does a low RVI value indicate?

A low RVI value of less than 50 is a bearish signal that indicates that there is an increased volatility to the downside, but a value below 20 requires caution as this is in oversold territory.

Summary

Although the RVI is not a popular indicator, it is a useful volatility indicator that can be used to confirm the trade signals generated by other technical indicators or technical analysis techniques. It gives insights to the direction in which volatility is moving so that a better understanding of market forces at that particular time can be achieved, which can be used to confirm trade signals. The addition of a signal line to the RVI allows it to generate potential trade signals. However, these signals should be confirmed by other technical indicators or technical analysis techniques.