DEFINITION of 'Random Walk Index'

The Random Walk Index is a technical indicator that compares a security’s price movements to random movements in an effort to determine if it’s in a statistically significant trend.

BREAKING DOWN 'Random Walk Index'

The Random Walk Index was created by Michael Poulos to determine if a security’s price is just a “random walk” or is the result of a statistically significant trend higher or lower. The technical indicator was originally published in Technical Analysis of Stocks and Commodities in 1991 in an article titled, “Of trends and random walks”.

Calculating the Random Walk Index

William Feller, a mathematician specializing in probability theory, proved that the bounds of randomness – or displacement distances – could be calculated by taking the square foot of the number of binary events (such as a coin toss). Any movement beyond these bounds suggests that the movement is not random in nature. The Random Walk Index applies these principles when measuring the uptrend and downtrend to determine if it’s random or not.

The calculation for high periods is: (HI – LO.n / (ATR.1(n) * SQRT(n)).

The calculation for low periods is: (HI.n – LO / (ATR.1(n) * SQRT(n)).

Using the Random Walk Index

The Random Walk Index is typically used over two to seven periods for short-term trading and eight to 64 periods for long-term trading, but traders may want to experiment with these numbers to see what works best for them.

Readings above 1.0 indicate that a security is trending higher or lower, while readings below 1.0 suggest that a security may be moving randomly. Often times, traders will enter a long position when the long-term RWI is greater than 1.0 and the short-term RWI lows peak above 1.0. Short positions may be entered when the long-term RWI of the lows is greater than 1.0 and the short-term RWI of the high peaks above 1.0.

The Bottom Line

The Random Walk Index is a technical indicator that compares a security’s price movements to random movements in an effort to determine if it’s in a statistically significant trend. In general, readings above 1.0 indicate that a security is trending, while readings below 1.0 indicate that the security’s prices may be random.

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