Wilder's Volatility

Wilder’s Volatility System, developed by and named after Welles Wilder, is a volatility index made up of the ongoing calculated average, the True Range. The True Range is always positive and is defined as the highest difference in value among today’s daily high minus today’s daily low; today’s daily high minus yesterday’s closing price; and today’s low minus yesterday’s closing price. The consideration of the True Range means that days with a low trading range (little difference between daily high and low), but still showing a clear price difference to the previous day, do not enter into the calculation with an erroneously low volatility.

 

Pane: Bottom

 

Calculation

 

  1. Calculate True Range (TR)
     

  2. Calculate Average True Range (ATR) for n period.
     

  3. Calculate Average True Range times Constant (ARC) - where constant (k) is between 2.8 and 3.1 (Workstation uses a default of 3.0)

    ARCt = ATRt * k
     

  4. Determine if initial-position (chronologically) is long or short. FutureSource assumes a short position if the close prior to the initial-position is less than the chronological-first close. If the inverse is true, FutureSource assumes a Long position. (i.e. in a 7-Day calculation: if Day_8_Close < Day_1_Close, then position for Day 9 is short. Day_8_Close (vs. day 7) is used because True Range cannot be calculated until day 2, therefore ATR [based on TR] cannot be calculated until day 8 and the current position is dependent on the prior day's values.) FutureSource's technique differs slightly from Wilder's discussion.

    Pi = Short if Ct-1 < C(t-n)-1

    Pi = Long if Ct-1  C(t-n)-1
     

  5. Determine Initial Significant Close - based on all prior closes (i.e. in a 7-Day calculation, the MIN or MAX of Day_1_Close through Day_8_Close to determine the SIC for Day-9)

    If Pi = Short, then SICi = MIN(Ct-1, Ct-2 ... C(t-n)-1)

    If Pi = Long, then SICi = MAX(Ct-1, Ct-2 ... C(t-n)-1)
     

  6. Determine initial Stop and Reversal (SARt):

    If Pi = Long, then SICi - ARCt-1

    If Pi = Short, then SICi + ARCt-1
     

  7. Determine subsequent values of Position, Significant Close and Stop And Reversal:
     

    1. If Pt-1 = Long, and if Ct-1 < SARt-1 then:

      Pt changes to Short

      SICt = Ct-1

      SARt = SICt + ARCt-1
       

    2. If Pt-1 = Long, and if Ct-1 SARt-1 then:

      Pt remains Long

      SICt = MAX(Ct-1, Ct-2 ... Ct-L)

      SARt = SICt - ARCt-1
       

    3. If Pt-1 = Short, and if Ct-1 > SARt-1 then:

      Pt changes to Long

      SICt = Ct-1

      SARt = SICt - ARCt-1
       

    4. If Pt-1 = Short and If Ct-1 SARt-1 then:

      Pt remains Short

      SICt = MIN(Ct-1, Ct-2 ... Ct-L)

      SARt = SICt + ARCt-1

 

 

ARC = Average True Range multiplied by Constant

ATR = Average True Range

C = Close price

i = initial value (chronologically first calculated)

k = Constant (Workstation uses 3.0)

L = length of current position

n = period length

P = Position

SIC = SIgnificant Close

SAR = Stop And Reversal

t = current interval

TR = True Range

 

Properties

 

Period: The number of bars in a chart. If the chart displays daily data, then period denotes days; in weekly charts, the period will stand for weeks, and so on. Period refers to the number of bars used to calculate the True Range Moving Average. Workstation uses a default value of 7.

 

Constant: Workstation uses a default value of 3.

 

Interpretation

 

Wilder’s Volatility System determines market volatility by calculating a smoothed average of the market price’s true range. True Range, developed by Welles Wilder to deliver a more realistic method to calculate price activity, is an indicator that measures price activity and directional movement and is defined as the distance a price moves per increment of time, e.g. from the lowest price to the highest price in a day. This system measures the trend in volatility in the base instrument, according to the True Range concept. A rising trend line shows a volatility increase in the security. A falling trend line shows a reduction in the instrument’s volatility. The ordinate values are not relevant.

 

Wilder’s Volatility System alone cannot trigger any trade signals, which means it must be used in conjunction with other indicator systems. A popular use is, for example, the Volatility Breakout System. Average True Range (ATR) represents the foundation for this. The aim of this system is to open a long position, as soon as the base instrument rises above its usual fluctuation margin and a short position as soon as it falls below its usual fluctuation margin.

 

The Volatility assists the trader in determining the market’s risk potential, as well as buy and sell opportunities. More volatile markets offer a greater risk/reward potential. There are traders who readily take on the risk for the potential of a greater profit, while, at the same time, there are traders who do not want to take such a risk.

 

Literature