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Random Walk Index
Description
In an effort to find an indicator that overcomes the effects of a
fixed look-back period and the drawbacks of traditional smoothing
methods, Michael Poulos developed the Random Walk Index. The Random
Walk Index is based on the basic geometric concept that the shortest
distance between two points is a straight line. The further prices
stray from a straight line during a move between two points in time,
the less efficient the movement.
Interpretation
Mr. Poulos found significant evidence during his research
that the "dividing line" between short- and long-term time frames
for most futures and stocks is right around eight to 10 days.
Therefore, he feels an effective trading system using the RWI can be
devised using two different time frames—a short-term RWI (two to
seven periods) for the market's frantic, random side and a long-term
RWI (eight to 64 periods) for the market's steady, trending side.
Peaks in the short-term RWI of highs tend to coincide with price
peaks. Peaks in the short-term RWI of lows tend to coincide with
price troughs.
Readings of the long-term RWI of highs above 1.0 provides a good
indication of a sustainable up trend. Readings of the long-term RWI
of lows above 1.0 provide a good indication of a sustainable
downtrend.
Therefore Mr. Poulus feels that an effective trading system could be
built that opens trades (after short-term pull-backs against the
direction of the long-term trend) using the following guidelines:
- Enter long (or close short) when the long-term RWI of the
highs is greater than 1.0, and the short-term RWI of lows peaks
above 1.0.
- Enter short (or close long) when the long-term RWI of the
lows is greater than 1.0, and the short-term RWI of highs peaks
above 1.0.
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