Varadi’s RSI(2) Alternative: The DV(2)
This is a test of an alternative to the blogosphere darling RSI(2) that I’m calling the DV(2). This indicator comes from David Varadi, a frequent commenter and friend of the MarketSci Blog. David works in the alt.-investment industry and is the keeper of the (rarely updated) CSS Analytics blog.
In this post, I’ll describe the DV(2) and show historical results of two strategies using it, and in a follow up post we’ll discuss.
The graph above shows the DV(2) from April to date. The simple unbounded version (blue, left scale) is calculated as follows: (a) for each trading day calculate: [(close / average of the high and low price) – 1]. And then (b) take the average of today and yesterday’s result.
This results in a value with no definite maximum or minimum value, so there is also a bounded version (red, right scale) that oscillates between 0 and 100 (like RSI(2)). To calculate the bounded version we take today’s unbounded value and compare it to the last year (252 trading days). The highest value over the last year receives a value of 100, the lowest 0, and everything else its percentage rank in between (in other words, we’re using the PERCENTRANK function in Excel).
Geek note: because this indicator requires high and low values, it is not appropriate for indices themselves (which report inaccurate high/low values), only intraday vehicles like ETFs.
The graph above shows the results of two different applications of DV(2) on the S&P 500 ETF SPY, from 2000, compared to buy & hold in grey. This is a proof of concept, so these results are frictionless (i.e. do not account for transaction costs, slippage, or return on cash).
The first strategy (blue) is going long at today’s close when the unbounded DV(2) falls below zero today, and closing that position and going short when it rises above.
DV(2) is similar to RSI(2) in that the deeper the market moves overbought or oversold, the more predictive it has become, so the second strategy (red) is using the bounded version of the indicator and scaling next-day exposure based on how close the indicator is to its extremes. A DV(2) of 50 results in a 0% position, 25 a 50% long position, 0 a 100% long position, etc.
And for the number lovers…
Like RSI(2) and other very short-term indicators, DV(2) only became useful around the turn of the century (hence the reason this test is so short). Since then, the indicator has obviously been an effective predictor of next-day mean-reversion.
In a follow up post I’ll look at where DV(2) and RSI(2) differ, and why DV(2) might be a much better alternative for ETF traders.
[Edit: click for a summary of all posts in this series on the DV(2) indicator]
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