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Created by Dr. Rene Koch, the variance ratio indicator measures the degree of mean reversion or trendiness in a time series. It is an easy and fast way to detect whether a security or price series is trending, mean reverting or following a random walk.
The variance ratio interpretation is as follow:
Above 1: The series is showing a tendency to form trends. This means that the series is likely to move in the same direction (compared to previous direction).
Below 1: The series is showing some degree of mean reversion. This means that series is likely to move in the opposite direction.
Equal to 1: This series is following a random walk. This means that it is impossible to predict the direction of the underlying security.
The trading indicator gets three parameters, which are a price series, a lookback period (to calculate return) and another period to use when calculating standard deviations.
Example:
test1 = VarianceRatio(close, 40, 200) > 1;
Check whether the security shows a tendency to form trends or not.
test2 = VarianceRatio(close, 40, 200) > 0.95 and VarianceRatio(close, 40, 200) < 1.05;
Check whether the security is following a random walk or not. We can include this rule in a trading system to ignore these unpredictable types of price series.
Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.
