Custom Search

The channel height ratio to one day figures given show a consistent excess beyond the square root column. This excess indicates the presence of trends and hints how to create a trend "yardstick." If no trends were present, the ratios would be expected to all fall exactly on the square roots, and thus an "expected random walk" over n days would be the square root of n multiplied by the average daily range (same as average one-day channel height).

We define the random walk index (RWI) as the ratio of an actual price move to the expected random walk. If the move is larger than a random walk (and therefore a trend), its index would be larger than 1.0. To keep track of where today's high is relative to previous lows and where today's low is relative to previous highs, we need two indices:

RWI of high=(H-Ln)/(Avg.mg.x n )
RWI of low=(Hn-L)/(Avg.mg.x n )

where "Hn" and "Ln" are the high and lows of n days ago and "avg rng" is the average daily range over the n days preceding today. In day-to-day use, these indices are calculated over a range of lookback lengths. Use the largest value returned for today's indicator. Thus, we let the market determine the lookback interval,rather than use a fixed arbitrary one as many current indicators do.

In addition, Figure 1 gives us a very important insight, showing the distribution of lookback lengths for the largest RWI (how many times did the largest RWI occur looking back two days, three days, four, five, six...?). Since the curve of Figure 1 bends at a fairly sharp corner, the entire curve can be approximated by only two straight lines. This means that the markets, to a very good approximation, can be thought of as displaying two distinct personalities. The corner of Figure 1 is showing us where the dividing line between short- and longterm behavior is, between seven and eight days. We therefore calculate two RWIS, one for short term (two to seven days' lookback), and one for longer-term (eight days and up). The short-term one is a good overbought/oversold indicator and the long-term one is a very good trend indicator.