Momentum strategies have outperformed other strategies such as mean reversion ones during the entire 2022 and the first half of 2023. However, most momentum strategies started to struggle during the last 1.5-2.0 months. Why is that? The reason is very simple: Nasdaq's intraday range started to contract suggesting lower intraday volatility and a more choppy environment.
To monitor this phenomenon, I developed a technical analysis tool, which I call a Relative Range Indicator. This indicator, which I apply to QQQ on TradingView, helps assess the intraday volatility and provides valuable insights to guide traders in choosing the most effective strategies to be deployed.
Understanding the Relative Range Indicator
The Relative Range Indicator operates by calculating the absolute difference between the opening and closing prices of QQQ within a single trading day. This difference is then subjected to an exponential moving average (EMA), which smooths out the data and highlights underlying trends.
This indicator is particularly useful for trend-following and momentum-based strategies, which often show the best performance when the NASDAQ's intraday range exceeds 1%. For instance, throughout most of 2023 and since January 2022, the indicator has remained well above 1%, signalling a period of heightened market volatility.
QQQ and the Relative Range Indicator
You see, recognizing the level of market volatility is crucial for day traders. During high volatility periods, when the Relative Range Indicator consistently exceeds 1%, the market often experiences significant price swings. These conditions are ideal for momentum-based strategies, which aim to capitalize on these large movements by following the current market trend. Conversely, when the Relative Range Indicator falls below 0.6% (and it has been flirting with this level for the last 1.5 months and finally dropped below it this week), it's a signal of a low volatility period. In such scenarios, the market typically experiences smaller price movements, making momentum (or trend following) strategies less effective.
Implementing the Relative Range Indicator
Now, let's get into the specifics of how to implement this indicator. Below is the code snippet for the Relative Range Indicator, written in PineScript for use in the TradingView platform.
You can also download the code here:
Remember, the Relative Range Indicator is not a standalone tool, but rather a guiding indicator to gauge the market's intraday volatility. Coupled with other technical analysis tools and market information, it can assist traders in making informed decisions and choosing the best strategies based on the market's current state of volatility.
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