average true range is often used as an indication of a ... · both rsis are calculated, the rsi...

1 | P a g e Questions or comments? Contact us at [email protected]

Average true range is often used as an indication of a security’s volatility. Although the

raw number alone does not imply high or low volatility, plotting the historical average true

range of a security allows you to view where volatility was decreasing, increasing, or

reaching a peak or a trough. In this paper, I will introduce an indicator and strategy that

try to take advantage of the increased trading opportunities that occur during times of

higher- or lower-than-average volatility for a stock when compared to the overall market.

This is accomplished by comparing the relative strength index (RSI) of the average true

range (ATR) of a specific stock to the relative strength index of the average true range of

the overall market.

In order to standardize the average true range of the security and the overall market, the

indicator calculates the RSI of the ATR. This helps standardize the changes in ATR of the

overall market versus the changes in ATR of a stock. The RSI of the ATR is calculated on

both the ATR of the overall market and the ATR of the security you want to trade. Once

both RSIs are calculated, the RSI spread is determined by dividing the RSI ATR calculation

of the tradeable security by the RSI ATR calculation of the market. We then take an

average of the RSI spread and look for trading opportunities by finding occurrences in

which the current RSI spread is greater or less than the average RSI spread. If the RSI

spread is above its average, then the tradeable security is currently experiencing higher

volatility than normally experienced when compared to the market. This is a bearish

signal and the strategy will correspondingly sell. If the RSI spread is below its average,

then the tradeable security is currently experiencing lower volatility than normally

experienced when compared to the market. This is a bullish signal and the strategy will

correspondingly buy.

To demonstrate the RSI Volatility Spread, I will introduce several indicators that plot the

RSI spread idea, as well as a strategy that uses the indicator’s results to generate buy and

sell signals. The strategy works well on several international market exchange-traded


funds (ETFs) as well as other sector ETFs. For demonstration purposes, I will present the strategy’s results

on the iShares MSCI Australia Index. However, I will also present a summary of results for several other ETFs

in the Portfolio Spotlight section. In Figure 1 below, you can view several strategy sample trades along with

the accompanying indicator that is plotting the average RSI spread difference. When the average spread

difference is above zero—signifying higher volatility—the histogram color is red to identify a bearish

outlook. When the average spread difference is below zero—signifying lower volatility—the histogram color

is green to identify a bullish outlook.

Strategy Style Intermediate Term

Asset Type Stocks

Symbol 1 (Traded Symbol) EWA - iShares MSCI Australia Index Fund

Symbol 2 $SPX.X - S&P 500 Index

Alternative Symbols to Trade IXC, IXJ, EWU, EWD, and EWL

Data Interval Daily

Period Tested 19 years


Buy when the average spread difference (AvgSpreadDiff) is below zero and the RSI of the ATR of the

market (S&P 500) is greater than the RSI of the ATR of the security you are trading.

Sell when the average spread difference (AvgSpreadDiff) is above zero and the RSI of the ATR of the

security you are trading is greater than the RSI of the ATR of the market (S&P 500).

Name Default Description

ATRLen 20 Length used to calculate the average true range of the security and of the overall market.

AvgLen 120 Length used to calculate average spread difference.

RSILen 50

Length used to calculate RSI of the ATR of the market and RSI of the ATR of the security. Also used to calculate the average RSI spread.

This strategy uses only three inputs and all of them are lengths used to calculate a variable. The same inputs are

used in the accompanying indicator. The first input, “ATRLen,” is used as the length to calculate the average true

range of both the tradeable security and the overall market, which we define as the S&P 500 Index. The second

input, “AvgLen,” is used only to calculate the length of the average spread difference, which is the difference between

the current RSI spread and the average RSI spread. The last input, “RSILen,” is used to calculate the RSIs of the ATRs

of the security and the market, respectively, and to calculate the average RSI spread. The average RSI spread, which

is defined in the strategy variables section below, is simply the ratio of the RSI of the ATR of the security and the RSI

of the ATR of the market.

Variable Definition

ATR Average true range of the security you are trading.

RangeMkt Range of the S&P 500 Index.

ATRMkt Average true range of the S&P 500 Index.

RSIATR Relative strength index of the ATR of the security.

RSIATRMkt Relative strength index of the ATR of the S&P 500 Index.

RSISpread

The relative strength index of the ATR of the security divided by the relative strength index of the ATR of the S&P 500 Index.

AvgSpread The exponential average of the RSI spread.

SpreadDiff The difference between the current RSI spread and the average of the RSI spread.

AvgSpreadDiff The exponential average of the difference between the current RSI spread and the average of the RSI spread.


In essence, this TradeStation Labs report introduces an alternative method by which to analyze a given

stock’s volatility. The concepts of RSI and ATR are very common in technical analysis. Here, we combine two

very familiar technical indicators to create a new one. The average spread difference, which is the indicator

that we use to generate the buy and sell signals, is a derivative of the two common indicators. Once we

standardize the average true range of both the stock and the market, the strategy looks for trading

opportunities in which the current RSI spread ratio is above the average RSI spread ratio. This means that

the current ratio between the volatility of the security and the market is higher than the average ratio

between the volatility of the security and the market. For high-beta securities, volatility should always be

higher than the overall market.

In this case, we are comparing not just volatility, but the ratio of volatility between the security and the

market. Because we are always comparing volatility to the market, in order for the strategy and indicator to

calculate accurately, the S&P 500 Index ($SPX.X) needs to be placed into the chart as Data 2. In Figure 2

below, you can see how the different variables appear plotted below the price data. Subgraph 2 plots the RSI

of the ATR of the security (purple line) against the RSI of the ATR of the market (orange line). With this

indicator, you can see historically when the security’s volatility was higher than the market’s volatility and

vice versa. In subgraph 3, the actual RSI spread (red line), or the ratio between the RSI of the ATR of the

security and the RSI of the ATR of the market, is plotted against the average RSI spread (blue line). When the

ratio is 1.0, the security’s volatility and the market’s volatility are approximately equal. Remember that in

order to calculate both the indicator and the strategy, the S&P 500 Index needs to be placed into the chart as

Data 2. In Figure 2, the price data of the S&P 500 is hidden by formatting the symbol and hiding the subgraph

in the Scaling tab.


In this paper, we’ve presented the strategy’s results for the iShares MSCI Australia Index Fund. However, this strategy would most likely be applied to a portfolio of securities, as it is an intermediate-term strategy and doesn’t generate many trades. In addition, the diversification effects of adding securities that are not perfectly positively correlated to a portfolio would help to reduce your portfolio’s overall risk.


Symbol Description K-Ratio RINA Index Buy and Hold Return Return on Account

EWA iShares MSCI Australia Index Fund 3.89 41.81 164.71% 742.45%

IXC iShares S&P Global Energy Sector Index 3.74 23.89 72.26% 675.24%

IXJ iShares S&P Global Health Sector Index 2.77 27.51 15.84% 728.60%

EWU iShares MSCI U.K. Index Fund 3.76 61.16 48.34% 535.57%

EWD iShares MSCI Sweden Index Fund 4.82 67.61 226.14% 625.93%

EWL iShares MSCI Switzerland Index 4.88 72.86 256.33% 777.48%

PBJ PowerShares Dynamic Food & Beverage 3.96 16.30 1.75% 2226.70%

PWC PowerShares Dynamic Market Portfolio 3.23 38.19 9.03% 3219.42%

XLP S&P Select Consumer Staples SPDR Fund 2.57 17.73 -1.28% 166.79%

Return on Initial Capital 177.75%

Buy and Hold Return 164.71%

Return on Account 742.45%

Annual Rate of Return 5.45%

Profit Factor 4.52

Avg Monthly Return $120.02

Std. Deviation of Monthly Return $685.44

Net Profit / Maximum Drawdown 5.06

Weekly Underwater Equity -15.64%

Buy and Hold Weekly Underwater Equity -68.25%

K-Ratio 3.89

RINA Index 41.81

The strategy’s profit factor of 4.52 signifies that for every $1.00 lost, $4.52 was earned in profit. The return on account—742.45% over the approximately 19 years that the strategy was back-

tested—far exceeded the buy-and-hold return of 164.71% (generated by simply buying at the beginning of the testing period and holding the security).

The K-ratio, which is a risk-adjusted performance measure, is 3.89. The higher the K-ratio, the better the strategy in terms of risk-adjusted performance. The industry standard is 2.50.

The strategy’s weekly underwater equity of (-15.64%) is much better than that seen under the buy-and-hold strategy of the security (-68.25%).

Average profit by month was positive 9 of 12 months, with January being the worst-performing month.

The detailed equity curve is fairly linear over the 19 years that the strategy was back-tested. The strategy was back-tested over the entire period during which the security was tradeable.

Risk-adjusted performance is consistent across several ETFs, as presented in the Portfolio Spotlight table.

The net profit divided by maximum drawdown ratio was 5.06, signifying low drawdown during the back-test.


Because the strategy is intermediate-term, it has a low number of total trades during the period (33). However, if the strategy were implemented on a portfolio of securities, the total number of trades would increase, allowing for more diversification and lower total risk.

The standard deviation of monthly return is 571% times the average monthly return, signifying higher risk in the strategy.

The last trade the strategy generated is currently a losing trade. The strategy had negative annual returns in 7 of the 19 years it was back-tested, with 2008 being the

worst-performing year (-8.20%).

This report introduced a new indicator to compare a given security’s volatility to overall market volatility in

order to generate buy and sell signals. As displayed in the relationship between the CBOE Volatility Index

($VIX.X) and the S&P 500 Index ($SPX.X), a spike in volatility may indicate a market downturn. This is

because a spike in the VIX usually means there is fear in the market. It is common knowledge that when

there is fear in the market, investors sell. This indicator and strategy try to take advantage of this

relationship by buying when volatility is lower than average compared to the market and selling when

volatility is higher than average compared to the market. Although the relationship does not always hold—

since higher volatility does not guarantee lower stock prices—it appears to hold more often than not over the

long term, allowing you to exploit these trading opportunities.

Alexandra Guevara is a Market Technician for TradeStation Securities.

In order to open the sample workspaces provided, you may first need to import the custom EasyLanguage file with the

extension .eld. Copy the attached .eld file and workspaces to your computer. Then import the indicators or strategies by double-clicking on the EasyLanguage .eld file. This will automatically start the TradeStation import wizard. Click ‘Next’ until the Analysis Techniques and/or strategies have been imported. The indicators are now available and you can now open the provided workspaces. Other supportive documents or files may also be attached to this email.

All support, education and training services and materials on the TradeStation Securities website are for informational purposes and to help customers learn more about how to use the power of TradeStation software and services. No type of trading or investment advice is being made, given or in any manner provided by TradeStation Securities or its affiliates.

This material may also discuss in detail how TradeStation is designed to help you develop, test and implement trading strategies. However, TradeStation Securities does not provide or suggest trading strategies. We offer you unique tools to help you design your own strategies and look at how they could have performed in the past. While we believe this is very valuable information, we caution you that simulated past performance of a trading strategy is no guarantee of its future performance or success. We also do not recommend or solicit the purchase or sale of any particular securities or derivative products. Any symbols referenced are used only for the purposes of the demonstration, as an example ---- not a recommendation.

Finally, this material may discuss automated electronic order placement and execution. Please note that even though TradeStation has been designed to automate your trading strategies and deliver timely order placement, routing and execution, these things, as well as access to the system itself, may at times be delayed or even fail due to market volatility, quote delays, system and software errors, Internet traffic, outages and other factors.

average true range is often used as an indication of a ... · both rsis are calculated, the rsi...

Documents