In the last post, I discussed the use of the Parkinson number as an indicator. In this post I will discuss a simple trend indicator you can use. Please read my volatility estimation post before attempting to read this post so it would make sense.
Background
In one of my posts, I discussed the method of sampling volatility (I recommend reading it now if you haven’t) . We assumed that there isn’t a problem in choosing an interval because we can then scale the sample to any interval we like. For example, if the daily volatility sampled was 1%, we can scale to figure out what would be the 20 day volatility by multiplying 1% by the square root of 20. This is the square root law. This results in 4.47% volatility. What happens now if instead of sampling on a daily basis, we sample on a monthly basis? Would the monthly sample yield the same calibrated result (4.47%) ? what does it mean if not?
The Method
If the volatility on an hourly sampled basis turns out to be higher than the volatility on a daily sampled basis, the market can be considered as not having a trend. If the hourly volatility was lower than the daily volatility, we can assume there is a trend.
An Example
Download this excel file to see the example. The first column are 30 samples of hourly prices of a stock, with the last price that is known is in the last row. The second column automatically computes the log returns of the stock and then scales it to daily volatility. The third column has a sample of daily prices of the stock. The 4th column then computes the daily volatility. We can now compare the volatilities.
The scaled daily volatility equals 0.0003 while the daily volatility equals 0.0001. This means that according to our rule of thumb, this is a mean-reverting market and hence no trend is present.
You can use this excel file to plug in different prices to suit your need. It will automatically compute all the other prices.
Final Note
This powerful tool can help you make a better decision towards determining trends. It adds a powerful tool to your trend indicators. For another trend indicator method see this trend indicator post.
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