Many birds display carotenoid-based ornaments, which are typically considered to be honest indicators of individual health and condition. Experimental work on male red-shouldered widowbirds, Euplectes axillaris, has demonstrated a function of the carotenoid-based epaulettes in male contests and territory acquisition. Using two experiments, we investigated whether the natural variation in this colour signal reveals male competitive ability. Males with larger and redder (more longwave) epaulettes established territories to the exclusion of males with smaller and less red signals, which formed a large population of 'floaters'. In an experiment in which we removed 42 resident males, these floaters rapidly filled up vacant territories. Among removed birds held in captivity, residents strongly dominated floaters in dyadic contests over access to an easily monopolized feeder (i.e. outside the context of territory defence). Only epaulette size predicted the outcome of these male contests. In addition, when competitors were experimentally given similar epaulette signals (removed or painted red to the average population size), the males were involved in more aggressive interactions than during unmanipulated contests, but residents continued to outcompete floaters. On release (after 8 days) to the breeding grounds, most residents (88%) rapidly reclaimed their territories from replacements. Combined, these results suggest that some intrinsic 'resource-holding potential', associated with the variation in epaulette signal, is primarily responsible for residents dominating nonresidents.