The Relative Vigor Index indicator (or RVI indicator) is an oscillator that gauges the strength behind a price move. It attempts to provide a guide to the propensity of the market to persist in the same direction of that move – or for the price move to break down.
How does the indicator do this?
It's based on the principle that in a rising market, we expect the closing price to be, on balance and in general, higher than the opening price. Similarly, in a falling market, we expect the closing price to be, more often than not, lower than the opening price.
In other words, at its core, this indicator tries to gauge whether a market is bullish or bearish in character. It does this by making a comparison between an instrument's closing price and its opening. By considering how this compares to the instrument's recent price range, the RVI gives a normalised measure of the oomph behind the move. This can help inform our opinion of how we expect the market to move going forward. This predictive ability means the RVI is labelled a leading indicator.
We calculate the RVI indicator via a number of steps. The core step is calculating the basic RVI value, using the following equation:
RVI = (close - open) / (high -low)
Let's break this down. The formula is looking at the difference between the closing price and the opening price – and then normalising it to the trading range over the period.
We then smooth our values of RVI over N periods by means of a Simple Moving Average (SMA). This is our main RVI oscillator line; it appears in MetaTrader as a green line, as we will see in the next section.
Many versions of the RVI indicator, in fact, perform a double smoothing. This first applies a symmetrically-weighted finite impulse response (FIR) filter, and this is then averaged over N periods. The precise mechanism of this isn't particularly instructive, so I will refrain from going deeply into it. Basically, the aim of the filter is to make the phase-cycle of the oscillator a better match for the phase cycle of the price chart. The key principle of the methodology to understand is that the RVI remains the ratio of the (close-open) to the (high-low).
The next step is to create a signal line. We do this by applying that same FIR filter to the RVI values – a symmetrically-weighted moving average of the RVI values over 4 periods. MetaTrader 4 plots the signal line in red on the same chart as the main RVI line.
The calculation method for the Relative Vigor indicator is actually very similar to that used for the Stochastic Oscillator, another very popular indicator. The Stochastic Oscillator uses price in comparison to the low of the day. In contrast, the RVI uses price in comparison to the high of the day, as we have seen.
Now, if you are concerned that the calculations above seem a little too involved, don't worry. It's useful to understand the basic principles behind how an indicator works, but the actual computational burden is all taken care of by MetaTrader 4. So, let's take a look at using the Relative Vigor Index indicator in MT4.
It's straightforward to use the RVI in MT4. The RVI comes bundled with the platform as one of its standard indicators, so that you don't need a separate download for the indicator. If you have MT4 installed on your device, you are ready to go.
You just need to look in the Oscillators folder in MT4's Navigator, as shown in the image below:
When you click on Relative Vigor Index, you will be prompted with the normal dialogue window that allows you to configure the indicator as you like. The key parameter that you can change is Period, which is the number of periods used for the main smoothing applied to the RVI oscillator. The default value is 10, as shown above.
You can also choose the colours used for these lines. The default is green for the RVI oscillator, and red for the signal line. In the image below, you can see the Relative Vigor Index indicator applied to an hourly EUR/USD chart:
The oscillator and the signal line both appear below the price chart. Note that the signal line basically reflects the main oscillator, but with a slight delay, and is slightly more smoothed.
The clearest points to consider are those times when the green and red lines cross. When the green line reaches a maximum or minimum, it should be telling us a change in the market from bullishness to bearishness, or vice versa. If we were just looking at the green line, we wouldn't know when these points had occurred until it was too late to react to them. The signal line gives us crossovers which should sign-post these key turning points in a, hopefully, timely manner.
Below is a daily EUR/USD chart with the RVI indicator added:
Notice how the green RVI line crossing under the red signal line coincides with the bearish stretches in the price? Also notice how the upward crosses signal periods where the market becomes either bullish or stops being bearish.
As the oscillator naturally moves in a wave pattern, we can attempt to add a rule to restrict trades to more favourable conditions. This would mean only acting on a crossover signal to buy if the RVI is below 0. Similarly, we would only act on a crossover signal to sell when it is above 0.
The time frame for your chart is an important choice. The indicator was originally devised, like so many other popular indicators, to be used in conjunction with end-of-day price data. So long as the principle holds true that a tendency to close higher during bullish phases (and lower in bearish phases), there is no reason that the indicator cannot be used for other time frames also.
Like any indicator, there are times when the RVI will provide false signals. One way to try and improve your confidence in a trading signal is to combine the Relative Vigor Index with another indicator. If you only trade when you see agreement in signals from your two indicators, it may improve their effectiveness. For example, you could check the Money Flow Index indicator to see if the market looks overbought or oversold.
Though MetaTrader 4 comes with a standard set of popular indicators, you might like to expand the selection available to you by downloading MetaTrader 4 Supreme Edition. MT4SE is a custom plugin developed by market professionals that vastly extends the functionality of MetaTrader 4.
To determine what is effective, you really need to play around in a risk-free environment. That way, you can see what works best and what doesn't work at all. This is why it's a sensible idea for beginners to have a Demo Trading Account. When you try your ideas out with a demo account, you aren't putting real money at risk, even though you are trading with real live price data.
The Relative Vigor Index is an indicator built on an assumption that the closing price of a period, say the end of the day, is a key characteristic tied to the force behind a market move. When the momentum of a market is bullish, we tend to observe higher closes. In a bearish market, we tend to see lower closing prices. Using this simple principle, the RVI indicator provides clear signals of when to trade, via its usage of a signal line, as we have seen.
Conventional wisdom dictates that leading indicators tend to be useful mainly in range-bound markets. You should be extremely wary of using the indicator in a trending market.
We hope you find the RVI indicator to be a useful aid for better understanding changes in the market. If you're interested in reading about another indicator that measures shifts in market behaviour, why not try our article on the Accumulation Distribution Indicator?