01/05/2019 A Volatility Based Momentum Indicator for Traders – Steve Roehling – Medium

A Volatility Based Momentum

Indicator for Traders
Steve Roehling Follow
Nov 25, 2018 · 5 min read

Fundamentally, trading is about analyzing the supply and demand of a

security (asset which can be traded), such as stocks, commodities, or
Forex pairs. A trader then makes decisions to purchase or sell these
securities, ideally for a profit. When entering a trade, there are
numerous factors to take into consideration, such key price levels,
liquidity, and momentum.

Momentum is the speed of movement for a security’s price. With

respect to supply and demand, a security with strong momentum is
experiencing an imbalance of demand over supply when price is rising,
or supply over demand when price is falling. To the extent momentum
is directly and fundamentally related to supply and demand, it is very
important for traders to have a means to measure and analyze a
security’s momentum.

The most pure and simple calculation of momentum is the following:

(Closing price today)- (Closing price n periods ago)

Going beyond a simple momentum calculation, there are numerous

technical analysis indicators a trader can use for a more sophisticated
analysis of momentum. For example, the rate of change (ROC)
indicator measures the percent change in price from one period to the
next. However, since many traders orient their trading around
volatility, a variation on ROC which is based upon volatility rather than
percentages offers numerous advantages.

Starting with the Rate of Change Indicator

The calculation of the percentage-based ROC indicator is the following:

ROC(n) = [(Close — Close n periods ago) / (Close n periods ago)] *

100

The ROC indicator shows when prices are surging or plunging. There is
no upper bound to the values from this indicator, but the maximum a

https://medium.com/@sroehling/a-volatility-based-momentum-indicator-for-traders-250957de978d 1/7
01/05/2019 A Volatility Based Momentum Indicator for Traders – Steve Roehling – Medium

price could plunge is 100%.

However, a primary shortcoming of the ROC indicator is its use of

percentages as a unit. For example, using percentages, one cannot
compare the momentum of two different stocks side by side, without
first knowing what is a normal percentage gain or loss is for each stock.

Calculating Volatility Based Momentum

Instead of basing the rate of change on percentages, expressing
momentum in ‘multiples of volatility’ (MoV) is another alternative. The
calculation for a volatility based momentum (VBM) indicator is very
similar to ROC, but divides by the security’s historical volatility instead.
The average true range indicator (ATR) is used to compute historical
volatility.

VBM(n,v) = (Close — Close n periods ago) / ATR(v periods)

For example, on a daily chart, VBM(22,65) calculates how many MoV

price has increased or decreased over the last 22 trading days
(approximately one calendar month).

Besides having a different unit than ROC, the VBM indicator has almost
an identical shape as the ROC indicator. Therefore, any technical
analysis and interpretation which would apply to ROC, applies equally
to VBM. Along these lines, below is an example chart for NVDA; this
chart illustrates the similar shapes of the ROC and VBM indicators,
even though they have different units:

https://medium.com/@sroehling/a-volatility-based-momentum-indicator-for-traders-250957de978d 2/7
01/05/2019 A Volatility Based Momentum Indicator for Traders – Steve Roehling – Medium

The chart used in the example above was created using the
TradingView charting website. In TradingView, custom indicators can
be created using their scripting language. The VBM indicator script
used in this example has been published on TradingView.

Trading Based On Multiples of Volatility

(MoV)
The key difference between VBM and ROC indicators is the VBM
indicator uses multiples of volatility (MoV) as its unit of measurement,
instead of a percentage gain or loss.

For traders who factor volatility more prominently than percentages

into their trading, VBM is arguably a more suitable alternative than
ROC. Traders can incorporate volatility in numerous ways. For
example, using the ATR indicator as a measure of volatility, traders can
use volatility in their assessment of risk versus reward, calculating stop
losses, determining price targets, and calculating position sizes. By
using VBM as a momentum indicator, traders can also evaluate
momentum in terms of volatility.

https://medium.com/@sroehling/a-volatility-based-momentum-indicator-for-traders-250957de978d 3/7
01/05/2019 A Volatility Based Momentum Indicator for Traders – Steve Roehling – Medium

Benefits of a Volatility Based Momentum

Indicator
The VBM indicator is a very simple variation on ROC. Given the
importance of volatility to many traders, I’d be surprised if other
traders aren’t already using something very similar, if not the same [1]
[2]. Whether or not VBM is an original concept, by elaborating on the
numerous benefits of VBM vs ROC, hopefully other traders can benefit
from the use of VBM as a technical analysis indicator.

Using VBM, MoV effectively serves as a normalized, universal unit of

measurement for momentum. By simply using MoV instead of
percentages as a unit, the VBM indicator realizes numerous
advantages.

First, the VBM indicator can be used with any type of security, such as
stocks or Forex. Unlike ROC, there is no need to reinterpret what a
percent gain or loss means for each. For example, below is a chart of
the EUR/USD Forex currency pair; using the VBM indicator, the values
can be interpreted in a similar manner as stocks/equities:

Using VBM, different stocks can be compared side by side without

having to discern what a normal percentage gain or loss is for the stock
in question. For example, traders will often have a watch list with
numerous stocks under consideration. Using charting software, a
trader will periodically cycle through a list of charts for each stock, re-
evaluating each one for possible entry. Using the VBM indicator, a

https://medium.com/@sroehling/a-volatility-based-momentum-indicator-for-traders-250957de978d 4/7
01/05/2019 A Volatility Based Momentum Indicator for Traders – Steve Roehling – Medium

trader can readily interpret the momentum of individual stocks, or

evaluate a stock’s momentum in relation to other stocks in the watch
list or the market as a whole.

Finally, VBM also works on multiple timeframes. Traders will often

evaluate an individual security on multiple timeframes, such and daily
and weekly timeframes. Since VBM uses the same unit of measurement
for all timeframes, momentum can be interpreted in a consistent
manner.

Summary and Next Steps

The VBM indicator offers numerous benefits to traders who orient their
trading around volatility. For these traders, VBM expresses momentum
in a normalized, universally applicable ‘multiples of volatility’ (MoV)
unit. Given the universal applicability of MoV, VBM is especially suited
to traders whose trading incorporates numerous timeframes, different
types of securities(e.g., stocks, Forex pairs), or the frequent comparison
of momentum between multiple instruments.

My own trading is definitely oriented around volatility. In this regard,

going forward I’m interested to look at other technical analysis
indicators to see if a variation with MoV as its unit is possible.

Footnotes:

[1] Even in my own trading, I’ve previously integrated volatility and

momentum. When trading stocks on an intraday (day trading) basis,
one useful measurement is a stock’s intraday price movement as a
multiple of daily volatility. This measurement tells you if the intraday
price movement is exceptional and has become “unhinged” from the
daily price.

[2] Similar to ATR, the standard deviation of price or returns is another

common measure of volatility. In the sharpe ratio, for example, a
standard deviation is the denominator to normalize returns based upon
risk and volatility. Also using a standard deviation, a “risk adjusted
momentum” investment strategy has been previously studied.
However, ATR is arguably better suited to traders who consistently use
ATR to determine risk versus reward, stop losses and price targets.

https://medium.com/@sroehling/a-volatility-based-momentum-indicator-for-traders-250957de978d 5/7
01/05/2019 A Volatility Based Momentum Indicator for Traders – Steve Roehling – Medium

https://medium.com/@sroehling/a-volatility-based-momentum-indicator-for-traders-250957de978d 6/7
01/05/2019 A Volatility Based Momentum Indicator for Traders – Steve Roehling – Medium

https://medium.com/@sroehling/a-volatility-based-momentum-indicator-for-traders-250957de978d 7/7