What is the random walk index?

Random walk index (RWI) is a technical indicator used to compare the price movements of a security to random movements to determine whether the security is in a trend. It is used by traders to determine whether the underlying asset is in a strong uptrend or downtrend.

In this article we will learn a detailed random walk index definition and take a look at how to calculate a random walk index.

Random walk index was published in 1999 by Michael Poulos in a US monthly Technical Analysis of Stocks & Commodities, in order to determine if a stock’s price movement is random or if it is trending significantly higher or lower. 

The random walk index has two lines: RWI High and RWI Low, which measure uptrend strength and downtrend strength, respectively. When either the RWI High or the RWI Low line is above one, it indicates that the current price movement of the underlying stock or asset is indicating a strong, non-random trend. 

Readings below one indicate that the current price movement could be random. When the RWI high line is above the RWI low line, it means there is more uptrend strength versus downtrend strength and vice versa.

It should be noted that the random walk index indicator uses past data to determine stock trends, therefore traders cannot depend upon it as a foolproof tool to predict future price movements of the market. 

Moreover, stock trends can quickly reverse in the event of market-moving news, change in investor sentiment and other various factors. The random walk index is best used in combination with other trading strategies.

Random walk index formula

Here are the random walk index formula to calculate the RWI High and RWI Low:

Over two to seven periods (or days) are typically used for short-term trading and eight to 64 periods are used for long-term trading. However, traders may choose to use settings that suit their market strategies and techniques best.

Random walk index example

To better understand what random walk index means, let’s look at an example of how to use this technical indicator.

Let’s take any random stock, say Tesla (TSLA), and apply a 14-period RWI indicator to its daily chart. If the price of Tesla stock starts to fall, the RWI Low will run above the RWI High. Similarly, when stock prices rebound and start to rise its RWI high line will run above the RWI Low.

In the event of a strong uptrend, the RWI High will move above 1.0 while RWI Low will fall below 1.0. Strong downtrend will push RWI Low above 1.0. 

When the stock is trading range-bound and is not signalling any trend, neither RWI High or RWI Low will maintain its position above 1.0 for long.