Random Walk Index Indicator is a technical indicator that determines if a security is trending or in a random trading range. By measuring price ranges over N the indicator can identify a strong uptrend or downtrend. The greater the range suggests the stronger trend. Traders can also use the indicator to generate buy-sell signals. So, let’s begin from the very basics.
What is the Random Walk Index Indicator?
Michael Poulos introduced the Random Walk Index in Technical Analysis of Stocks and Commodities magazine. The main purpose of the indicator is to determine whether the price is significantly trending or whether it just makes random movements ups and down. Though it was developed specifically for the stock market, traders can use this for all asset types and all time frames.
The more random the asset price movement, the more the Random Walk Index fluctuates. The short-term (2 to 7 periods) Rwi is an overbought or oversold indicator, and the long-term (8 to 64 periods) RWI is a trend indicator. Financial security is trending higher when the RWI of the highs is greater than 1. And, on the other side, a downtrend is indicated if the Rwi of the lows is greater than 1.
The Formula of the Random Walk Index Indicator
By using a certain mathematical principle, you can calculate the uptrend and downtrend. As a result, you can determine if it’s random or statistically meaningful.
As the indicator measures both uptrend and downtrend, the calculation requires separation.
High periods, or Random Walk Index High calculation, is:
The formula is High minus Low(n) divided by the average true range (ATR) multiplied by the square root of n.
Therefore, if you are calculating the RWI High of the last five days, here take the high from today and minus the low from the prior period and calculate RWI High. Then, calculate using today’s high minus the low for two days before. Do these steps for each day and go back to five trading sessions.
Now, the RWI High value is the highest value of the last five days or for many periods (n) chosen.
On the other side, we can calculate RWI Low as follows:
Here, the formula is High(n) minus Low divided by the average true range (ATR) multiplied by the square root of n.
The process is similar to the approach above, except now you will use today’s low and the high from the previous period to create the first calculation. After that, use the high from two days ago. Do these steps for each of the n periods.
How to Attach the Random Walk Index Indicator to the Charts?
If traders want to use the Random Walk Index (RWI) indicator, then they can find it in the STUDIES section of Zerodha Kite. Also, this is available in the Kite mobile App. The default PERIOD is 14 and you can set the colors of the high and low. You can check how we attached the Random Walk Index indicator in Reliance Industries’ share price chart. This works on any charts like daily, weekly, monthly, or intraday you can attach.
Now, come to another charting platform Upstox Pro. Just like Zerodha Kite, open Upstox Pro. Then select any chart and type down the indicator name on the search box. Finally, click on apply.
How to Use the Random Walk Index Indicator?
Random Walk Index or RWI indicator is mainly a combination of two lines the red line and the green line. The red line denotes the strength of the downward movement. And on the other side, the green one denotes the strength of the upward movement.
Identifying Range or Trend
There are also multiple levels — horizontal lines marked as 1, 2, and 3. Once green and red lines fluctuate around ‘1’, most price moves are random. And, once either of the lines moves above ‘2’, the price action can be attributed to a trend.
Identifying a Strong Trend
Now, if one of the lines crosses ‘3’ from below, a particularly strong trend is observed. Here, a trader can consider opening a BUY position once the green line is above 1.5. And, the red line is below 1 level.
Reversely, open the SELL position when the red line is above 1.5, and the green line is below 1 level. We consider all moves below 1 as random price fluctuations.
You can combine it with any other momentum or volatility indicator. MA or Moving Average also works quite well. Hence, you can use RWI as a supportive tool that will confirm signals sent by other indicators. The second strategy will generally mean that you receive fewer signals but of higher advanced quality.
Using a Crossover
Few traders may look to use crossovers of the two lines to determine potential trades. This will work well once strong trends develop. But it will result in lots of losing trades if the stock price doesn’t trend well since crossovers could occur without a strong trend resulting. That said, few traders may wish to utilize this approach, basically in conjunction with other forms of technical analysis.
FAQ
The Random Walk Theory (EMH) states that stock prices move randomly and cannot be predicted or influenced by past data. It implies that it’s impossible to consistently outperform the market by investing in individual stocks.
Stock prices are known to follow a random walk when they are affected by a range of factors like supply and demand, macroeconomic events, investors’ sentiment, etc, which cannot be accurately predicted or measured.
RWI stands for Random Walk Index – an indicator used to measure price swings against expected behavior. It compares observed price movements over different periods with those predicted by probability laws such as Brownian motion models.
An example would be if you flip a fair coin 10 times and take note of whether it lands on heads or tails each time – you will get 5 heads out likely, but you can not guarantee it. This unpredictable outcome matches what happens when observing stock markets where outcomes are equally unpredictable but over longer time frames certain patterns begin to form making them relatively easier to predict than single flips of coins.
Conclusion
In whole indicators, most technical indicators use a fixed period to smooth and filter or normalize data. Also, this fixed period is used because most of the indicators support the existence of persistent cycles. This indicator tries to determine whether a stock price change is random or not by measuring price ranges over previous bars and comparing them to a random walk. In Random Walk Index, the length of the look-back is chosen depending on market price action. However, the indicator won’t help to measure the duration of the trend. But there is one trick that is, as a rule, stronger ones take longer to fade away. And the Random Walk Index is perfectly capable of identifying the trend strength.