Random Walk Index Definition
The random walk index (RWI) is a technical indicator that attempts to determine if a stock’s price movement is random or nature or a result of a statistically significant trend. The random walk index attempts to determine when the market is in a strong uptrend or downtrend by measuring price ranges over N and how it differs from what would be expected by a random walk (randomly going up or down). The greater the range suggests a stronger trend. The RWI states that the shortest distance between two points is a straight line and the further prices stray from a straight line, implies the market is choppy and random in nature.
Random Walk Index Formula
The random walk index determines if a security is in an uptrend or downtrend. For each period the RWI is computed by calculating the maximum of the following values for high periods:
(HI – LO.n) / (ATR.1(n) * SQRT(n))
For each period the RWI is computed by calculating the maximum of the following values for low periods:
(HI.n – LO) / (ATR.1(n) * SQRT(n))
Trading with the Random Walk Index
Michael Poulos the creator of the RWI, discovered during his research that it was best optimized for 2 to 7 periods for short-term trading and 8 to 64 periods for long-term trading. Readings of the long-term RWI of highs that exceed 1 provides a good indication of a sustainable uptrend. Conversely, a long-term RWI of lows above 1 provide a good indication of a sustainable downtrend. Poulous realized that by combining the short-term RWI with the long-term RWI in a trading system, it could provide accurate buy and sell points. Below are some rules developed by Poulos for trading stocks and futures with his RWI:
- Enter a long (or close short) when the long-term RWI of the highs is greater than 1 and the short-term RWI of lows peaks above 1
- Enter short (or close long) when the long-term RWI of the lows is greater than 1 and the short-term RWI of highs peaks above 1
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