Traders are continuously seeking reliable indicators to navigate the complexities of trading. Among the myriad of tools available, the relative vigor index (RVI) emerges as a potent momentum oscillator. Developed by John Ehlers, the RVI offers distinct insights into market strength and potential reversals, making it a valuable asset for traders of all levels. In this comprehensive guide, we embark on a journey to unlock the full potential of the relative vigor index. From understanding its calculation intricacies to exploring practical applications in trading strategies, this guide aims to equip traders with the knowledge and skills needed to harness the power of the RVI effectively.

Understanding and Calculation of Relative Vigor Index

The Relative Vigor Index is a momentum oscillator that compares the closing price to the trading range over a given period. The RVI is calculated using a complex formula that takes into account multiple data points over a specified period. The numerator calculates the average difference between the closing and opening prices, while the denominator calculates the average trading range. The RVI is then derived by dividing the simple moving average (SMA) of the denominator by the SMA of the numerator over the same period.

where:

a=Close−Open
b=Close−Open one bar prior to a
c=Close−Open one bar prior to b
d=Close−Open one bar prior to c
e=High−Low of bar a
f=High−Low of bar b
g=High−Low of bar c
h=High−Low of bar d

In addition to the RVI line, traders often utilize a signal line to further refine their trading decisions. The signal line is calculated by applying a smoothing function to the RVI line itself. A crossover of the RVI line above the signal line is considered bullish, while a crossover below the signal line is deemed bearish.

where:

i=RVI value one bar prior
j=RVI value one bar prior to i
k=RVI value one bar prior to j

RVI Crossover Strategy

Example of bullish crossovers of RVI line above the signal line. 1h time frame, SPY ETF, TradingView.

The RVI is particularly valuable in identifying periods of heightened momentum within the market. By closely monitoring the magnitude and direction of the RVI line, traders can pinpoint opportune moments to capitalize on momentum-driven price movements. Entry signals are often generated based on bullish crossovers above the signal line or bearish crossovers below the signal line. A bullish crossover, where the RVI line surpasses the signal line from below, signifies a potential increase in bullish momentum and presents an opportunity for traders to enter long positions. Conversely, a bearish crossover, occurring when the RVI line falls below the signal line, suggests a strengthening bearish sentiment, prompting traders to consider short positions. By aligning their trades with momentum signals derived from the RVI, traders can exploit favorable market conditions and optimize their trading outcomes.

RVI Divergence Strategy

Divergence between price movement and the RVI line. 1D time frame, SPY ETF, TradingView.

In addition to its role in trend confirmation and momentum identification, the RVI can also serve as a powerful tool for anticipating trend reversals. Traders can leverage divergences between price movements and the RVI line, coupled with overbought or oversold readings, to anticipate potential shifts in market sentiment. Bullish divergence occurs when the price forms lower lows while the RVI forms higher lows, indicating a potential reversal from bearish to bullish sentiment. Conversely, bearish divergence manifests when the price forms higher highs while the RVI forms lower highs, signaling a potential reversal from bullish to bearish sentiment. To validate these reversal signals, traders may seek confirmation from other technical indicators or conduct thorough price action analysis. By effectively identifying trend reversals in advance, traders can capitalize on emerging opportunities and optimize their trading strategies for enhanced profitability.

Limitations of Relative Vigor Index

While the relative vigor index is indeed a valuable tool for technical analysis, it’s crucial to acknowledge and address its limitations to ensure informed decision-making in trading. One such limitation involves the potential for false signals, which is inherent in all technical indicators, including the RVI. Particularly in choppy or range-bound markets, traders should exercise caution and supplement RVI signals with additional analysis to confirm their validity. Additionally, the effectiveness of the RVI can be influenced by various parameters, such as the look-back period and the smoothing factor for the signal line. Traders must conduct thorough backtesting and optimization to identify the optimal settings for their specific trading strategy, considering factors like market conditions and risk tolerance. ​

Backtesting with Historical Data and Excel Spreadsheet

Backtesting is a crucial step in evaluating the effectiveness of any trading strategy, including those involving the relative vigor index. By backtesting with historical data, traders can assess the performance of their RVI-based strategies under various market conditions and refine their approach accordingly. Here’s how you can conduct backtesting using historical data and an Excel spreadsheet.

Historical Data Collection

Begin the backtesting process by acquiring comprehensive historical price data for the specific financial instrument you intend to trade. This data is pivotal for accurately assessing the performance of your trading strategy based on the relative vigor index. Historical price data typically encompasses the opening, high, low, and closing prices for each trading period, which could be daily, weekly, or monthly, depending on your preference and the frequency of your trading strategy.

To gather this data, you can utilize various sources, including financial websites, trading platforms, data providers, or APIs (Application Programming Interfaces) that offer historical price data for the desired asset. You can start with Investing.com which provides free historical data in 1D time frame. Ensure that the dataset covers a sufficiently extensive time horizon to encompass various market conditions and price movements, allowing for a comprehensive evaluation of your trading strategy.

Calculation of RVI and Signal Line in Excel Spreadsheet

Once you have assembled the historical price data, the next step involves computing the relative vigor index and signal line values for each trading period in your dataset. To perform these calculations in Excel, input the relevant price data, including opening, high, low, and closing prices, into separate columns or rows within your spreadsheet. Then, apply the formulas provided earlier in this guide to compute the RVI and signal line values for each trading period.

For the RVI calculation, determine the average difference between the closing and opening prices (the numerator) and the average trading range (the denominator) over the specified period. Finally, derive the RVI by dividing the SMA of the numerator by the SMA of the denominator. Similarly, compute the signal line by applying a smoothing function to the RVI values. You can download Excel template for RVI indicator which was created for your convenience.

RVI calculation with Excel

Once you have calculated the RVI and signal line values, identify trading signals based on crossover events and divergence patterns, as described earlier in this guide. Record these signals in your spreadsheet, marking whether they correspond to bullish or bearish indications.

Next, simulate trades based on the generated signals to assess their profitability. For each signal, determine the entry and exit points, as well as the size of the position (e.g., number of shares or contracts). Calculate the resulting profit or loss for each simulated trade.

Analyze the performance of your RVI-based trading strategy by examining key metrics such as the total number of trades, win rate, average profit per trade, maximum drawdown, and overall profitability. Compare these metrics to benchmark values and assess the strategy’s consistency and robustness.

If necessary, refine your trading strategy by adjusting parameters such as the look-back period for the RVI calculation or the threshold levels for identifying signals. Conduct additional backtesting iterations to evaluate the impact of these changes on performance.

Final Thoughts

The relative vigor index is a versatile momentum oscillator that provides valuable insights into market strength and potential reversals. By understanding its calculation, interpretation, and practical application in trading strategies, traders can leverage the RVI to enhance their decision-making process and improve trading outcomes. However, like any technical indicator, it’s crucial to use the RVI in conjunction with other tools and exercise prudent risk management to navigate the dynamic nature of financial markets effectively. By conducting thorough backtesting with historical data and leveraging Excel spreadsheet capabilities, traders can gain valuable insights into the viability and effectiveness of their RVI-based trading strategies. Through iterative testing, optimization, and refinement, traders can enhance their decision-making process and increase their chances of achieving consistent trading success in the dynamic world of financial markets.

FAQ About Relative Vigor Index