How to Use the Relative Vigor Index in Trading

The Relative Vigor Index (RVI) is an indicator that calculates the power behind price movements. In essence, the RVI indicator attempts to gauge when the market will reverse from the current uptrend or a downtrend. 

In this blog post we look at the key characteristics of the relative vigor index indicator, how it is calculated, as well as its strengths and weaknesses. Finally, we will be sharing advice on how to design a simple trading strategy based on the RVI indicator.

The RVI indicator is based on an idea that the price action has a tendency to close higher compared to the opening prices in an uptrend, and have lower closing prices than opening in a downtrend. 

A formula to measure the RVI is as follows:

​NUMERATOR =  a+(2×b)+(2×c)+d

                                       6

DENOMINATOR = e+(2×f)+(2×g)+h

                                         6

RVI = SMA of NUMERATOR for N periods

        SMA of DENOMINATOR for N periods

Signal Line = RVI+(2×i)+(2×j)+k

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Where:

• a=Close−Open

• b=Close−Open One Bar Prior to a

• c=Close−Open One Bar Prior to b

• d=Close−Open One Bar Prior to c

• e=High−Low of Bar a

• f=High−Low of Bar b

• g=High−Low of Bar c

• h=High−Low of Bar d

• i=RVI Value One Bar Prior

• j=RVI Value One Bar Prior to i

• k=RVI Value One Bar Prior to j

• N=Minutes/Hours/Days/Weeks/Months

As you can see from the formula the RVI also has a signal line that interacts with the indicator. Based on the crossovers and divergences between these two, we extract the trading signals.

As many other trading platforms, MetaTrader 5 has a built-in RVI indicator. You simply choose the indicator from a drop-down menu and it will show up automatically on your chart. The default setting is based on 10 periods, in addition to a green color for the RVI oscillator, and red for the signal line.

The RVI indicator fluctuates around the center line and it travels from above to below zero, and vice versa. As you can see from the photo below, the values are rising as the price trades in a bullish environment and vice versa. The indicator is classified as a centered oscillator, since it oscillates around the center line rather than a banded oscillator.

On the other hand, the key weakness associated with the RVI is that it is practically useless in the ranging markets, when the price action doesn’t move in a clear uptrend or downtrend. Hence, traders tend to usually consult the RVI when the price action trades in the uptrend or downtrend for a longer period of time, as they try to predict when the current trend will end. 

As noted earlier, the RVI indicator interacts with the signal line, creating different types of signals. For instance, a trading signal is generated when the RVI moves above the signal line. This situation is called a bullish crossover and it indicates that the price action is likely to start moving upwards. The bearish crossover is the opposite of the bullish crossover i.e. the RVI crosses below the signal line. 

On the other hand, the interaction between the RVI and the price action can produce a bullish and bearish divergence. The former occurs when the RVI creates a higher low or a higher high, while the price action creates a new low. It signals that the price action is likely to start following the RVI higher.

The latter takes place in the opposite scenario - the price action is still trading in an uptrend, but the RVI has already started to come off the highs, which implies that the asset’s price will start following the RVI in moving lower. 

There are many different trading strategies based on the RVI indicator, as it is the case with the RSI and other oscillators. The vast majority of those are centered around either crossovers or divergence. 

Here we are sharing a very simple trading strategy that tends to mix these two scenarios - a crossover and divergence. This way we get two signals pointing to the same future development - a reversal.

In a chart below, you see USD/CAD moving lower, below the most recent low. The RVI follows and creates a short-term low, trading extremely close to its minimum levels. Remember that the RVI should only be consulted in the trading markets.

The RVI then generates two bullish signals. First, the crossover occurs as the RVI indicator (the green line) moves above the signal line (the red line), signaling that the trend is likely to change from bearish to bullish. 

Secondly, the price action creates a series of consecutive lower lows, a situation which is not confirmed by the RVI, which starting with a crossover continues to move higher. As we noted earlier, this situation is called a bullish divergence and it signals that the price action may start following the RVI higher soon. 

At this point, two bullish signals convince us to open a trade and look for a reversal. We opened a long trade aiming to capitalize on the impending trend reversal as the sellers seemed to have run out of gas.

The entry should be placed once both the crossover and the divergence issue bullish signals. The stop loss is placed around 40 pips below, to allow for the price action to potentially create another short term low. 

Take profit is determined by searching for a “magnet level” - an important price point that played an important role in the past. This can be either a Fibonacci retracement/extension, moving average, trend line etc. In this case, we use the previous swing low, which is now likely to act as a resistance. 

Ultimately, the price action creates a sharp reversal, surging higher and hitting our take profit order in just two days. In this trade, we risked 40 pips to make around 80 pips, which translates to a 1:2 risk-reward.