Summary
Average true vary is commonly used as a sign of a safety’s volatility. Although the uncooked quantity alone doesn’t indicate excessive or low volatility, plotting the historic common true vary of a safety means that you can view the place volatility was lowering, growing, or reaching a peak or a trough. In this paper, I’ll introduce an indicator and technique that attempt to reap the benefits of the elevated buying and selling alternatives that happen throughout occasions of higher- or lower-than-average volatility for a inventory when in comparison with the general market. This is completed by evaluating the relative power index (RSI) of the typical true vary (ATR) of a selected inventory to the relative power index of the typical true vary of the general market.
Calculation
In order to standardize the typical true vary of the safety and the general market, the indicator calculates the RSI of the ATR. This helps standardize the modifications in ATR of the general market versus the modifications in ATR of a inventory. The RSI of the ATR is calculated on each the ATR of the general market and the ATR of the safety you wish to commerce. Once each RSIs are calculated, the RSI unfold is set by dividing the RSI ATR calculation of the tradeable safety by the RSI ATR calculation of the market. We then take a mean of the RSI unfold and search for buying and selling alternatives by discovering occurrences wherein the present RSI unfold is larger or lower than the typical RSI unfold. If the RSI unfold is above its common, then the tradeable safety is presently experiencing greater volatility than usually skilled when in comparison with the market. This is a bearish sign and the technique will correspondingly promote. If the RSI unfold is beneath its common, then the tradeable safety is presently experiencing decrease volatility than usually skilled when in comparison with the market. This is a bullish sign and the technique will correspondingly purchase.
To reveal the RSI Volatility Spread, I’ll introduce a number of indicators that plot the RSI unfold concept, in addition to a technique that makes use of the indicator’s outcomes to generate purchase and promote indicators. The technique works nicely on a number of worldwide market exchange-traded funds (ETFs) in addition to different sector ETFs. For demonstration functions, I’ll current the technique’s outcomes on the iShares MSCI Australia Index. However, I may even current a abstract of outcomes for a number of different ETFs within the Portfolio Spotlight part. In Figure 1 beneath, you possibly can view a number of technique pattern trades together with the accompanying indicator that’s plotting the typical RSI unfold distinction. When the typical unfold distinction is above zero –signifying greater volatility– the histogram coloration is pink to establish a bearish outlook. When the typical unfold distinction is beneath zero –signifying decrease volatility– the histogram coloration is inexperienced to establish a bullish outlook.
Strategy Strengths
The technique’s revenue issue of 4.52 signifies that for each $1.00 misplaced, $4.52 was earned in revenue.
The return on account — 742.45% over the roughly 19 years that the technique was back-tested — far exceeded the buy-and-hold return of 164.71% (generated by merely shopping for originally of the testing interval and holding the safety).
The Ok-ratio, which is a risk-adjusted efficiency measure, is 3.89. The greater the Ok-ratio, the higher the technique by way of risk-adjusted efficiency. The business commonplace is 2.50.
The technique’s weekly underwater fairness of (-15.64%) is a lot better than that seen underneath the buy-and-hold technique of the safety (-68.25%).
Average revenue by month was constructive 9 of 12 months, with January being the worst-performing month.
The detailed fairness curve is pretty linear over the 19 years that the technique was back-tested. The technique was back-tested over the whole interval throughout which the safety was tradeable.
Risk-adjusted efficiency is constant throughout a number of ETFs, as introduced within the Portfolio Spotlight desk.
The web revenue divided by most drawdown ratio was 5.06, signifying low drawdown throughout the back-test.
Strategy Weaknesses
Because the technique is intermediate-term, it has a low variety of complete trades throughout the interval (33). However, if the technique have been applied on a portfolio of securities, the full variety of trades would improve, permitting for extra diversification and decrease complete threat.
The commonplace deviation of month-to-month return is 571% occasions the typical month-to-month return, signifying greater threat within the technique.
The final commerce the technique generated is presently a dropping commerce.
The technique had adverse annual returns in 7 of the 19 years it was back-tested, with 2008 being the worst-performing yr (-8.20%).