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 1 | P a g e Questions or comments? Contact us at [email protected] 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 2 | P a g e Questions or comments? Contact us at [email protected] 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 Length used to calculate the average true range of the ATRLen 20 security and of the overall market. AvgLen 120 Length used to calculate average spread difference. Length used to calculate RSI of the ATR of the market and RSI of the ATR of the security. Also used to RSILen 50 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. The relative strength index of the ATR of the security divided by the relative strength index of the ATR of the RSISpread S&P 500 Index. AvgSpread The exponential average of the RSI spread. The difference between the current RSI spread and the SpreadDiff average of the RSI spread. The exponential average of the difference between the AvgSpreadDiff current RSI spread and the average of the RSI spread. 3 | P a g e Questions or comments? Contact us at [email protected] 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. 4 | P a g e Questions or comments? Contact us at [email protected] 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. 5 | P a g e Questions or comments? Contact us at [email protected] 6 | P a g e Questions or comments? Contact us at [email protected] 7 | P a g e Questions or comments? Contact us at [email protected] 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.