It seems that traders are becoming increasingly interested in the classical methods of technical analysis, and the use of trading channels have become popular again in the 21st century. Since Williams Volatility Channel is getting very popular among traders, you may be wondering what it is.
Williams Volatility Channel is a trend-following indicator developed by Larry Williams. The indicator is a channel with upper and lower bands, with the gap between the bands indicating the level of volatility in the market. When there is high volatility, the gap widens and when volatility is low, the gap diminishes.
We start the article by explaining the theory behind the indicator, and we end the article by doing some backtesting Williams Volatility Channel.
What is the Williams Volatility Channel?
Williams Volatility Channel is a trend-following indicator developed by Larry Williams. The indicator is a channel with upper and lower bands, with the gap between the bands indicating the level of volatility in the market. When there is high volatility, the gap widens and when volatility is low, the gap diminishes.
Below is a chart that shows the channel on SPY (S&P 500) in Amibroker:
The indicator focuses on the price action and uses the day’s price range (the difference between the high and low prices of the day) to gauge the volatility in the market. The previous day’s range is added to the day’s close to get the up point, while it is subtracted from the day’s close to get the lower point. In most cases, a 3-day moving average of the upper points and lower points are calculated to get the upper and lower boundaries, giving rise to a channel.
However, there are different modifications of the channels out there. Some of the popular ones use the typical price (an average of the high, low, and close prices), instead of the price range, in estimating the up point and low point. Whichever method is used, the channel can be used to gauge the market volatility, as well as track the trend in the market.
On trading platforms that have the indicator, the function has two parameters: the lookback period, which is used to calculate the higher and lowest channel levels or the moving average, and the band type — value that determines whether to return the upper or the lower band. To get the lower band set this value to one and to get the upper band set this value to zero.
Since they are built through high prices and low prices, the result is a dynamic trading channel that opens when volatility is high and closes when volatility is low.
What is the formula?
There are different methods for calculating and deriving Williams Volatility Channel. Some use the price range while others use the typical price.
Upper point = previous day’s price range + today’s close
Lower point = previous day’s price range – today’s close
Then a 3-day average of the upper and lower points gives the upper boundary and lower boundary of the channel respectively.
Another version, which uses the typical price, is calculated as follows:
//parameter :
// Vc = 10
Up = Highest[Vc]((((High+Low+Close)/3)*2)-High)
Lo = Lowest[Vc]((((High+Low+Close)/3)*2)-Low)
Who invented the Williams Volatility Channel?
Williams Volatility Channel was developed by Larry Williams, a trader in the U.S. and the author of several trading books. He described it in his book: Long-term Secrets to Short-term Trading. The indicator is based on the concept that if the market makes a movement of a certain size in a short period of time, this movement will continue for some time.
What does the Williams Volatility Channel tell you?
As with other volatility channels (such as the Bollinger bands and Donchian Channel), Williams Volatility Channel moves with the price and quickly adjusts to changes in price movements. When the price trends above the volatility channel, it indicates a possible emergence of an uptrend. And, the bands respond by opening up. The same happens when the price breaks below the channel to signal a downtrend.
The channel normally points to a key Fibonacci support/resistance zone, so a retracement from its upper and lower limits could be used for opening short and long positions, respectively. However, the breakout strategy is mostly traded, where the channel is used as a confirmation rule to enter long or short trades. Long trades are taken when the price breaks above the upper volatility band, while short trades are triggered when the price breaks down the lower volatility band.
Some use the retracement to the opposite boundaries to get trade signals. In this case, a buy signal is triggered after a false breakdown of the lower channel, while a short signal is triggered when there is a false breakout of the upper channel.
Williams Volatility Channel trading strategies
Let’s backtest some Williams Volatility Channel trading strategies. We have never backtested the indicator before. When we start backtesting a new indicator, we like to use strategy optimization. By doing this we get a “feel” for how the indicator works at different time spans (the number of days).
We backtest Williams Volatility Channel on S&P 500 by using the ETF with the ticker code SPY.
Williams Volatility Channel trading strategy no. 1
The first strategy is like this in plain English:
- We use an N-day lookback period.
- We go long when the close crosses above the upper volatility channel.
- We sell when the close crosses below the lower volatility channel.
If we test by using lookback periods from 2 to 10 days we get the following table:
The first column shows the result when we use an N-day lookback period from 2 to 10 days. This means we buy on short-term strength and sell on weakness. This is not a good recipe for making money in the stock market!
Let’s flip the rules:
Williams Volatility Channel trading strategy no. 2
The rules in plain English are like this:
- We use an N-day lookback period.
- We go long when the close crosses below the lower volatility channel.
- We sell when the close crosses above the upper volatility channel.
The table looks like this:
The results improve considerably but are still far from a good trading strategy. The fourth row shows the profit factor and it’s lower than our minimum requirement of 1.75.
Let’s look at the equity curve of the best lookback period (10 days):
It’s rather erratic and has large drawdowns. The average gain per trade is 0.62, but there are better indicators out there with lower estimated drawdowns.
Volatility strategy bundle
We have put together a strategy bundle that consists of 3 strategies for the S&P 500. You can find more info on this link:
Williams Volatility Channel – conclusion
The Williams Volatility Channel is one of many volatility indicators and it looks like there are better volatility indicators out there, for example, the VIX indicator and Donchian Channels. When we backtest an indicator, we always try to “tweak” by adding a variable, but to no avail on the Williams Volatility Channel.
