RSI indicator trading
strategy, 5 systems + back test results!
Roman Sadowski – Humbletraders RSI indicator trading strategy, 5 systems + back test results!RSI indicator trading strategy – 5 systems
and the back test results!
Digging into the quintessential overbought oversold indicator!
The RSI indicator is a cruel mistress!
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!
She lure’s us in with promises of easymoney and trading success,only to drain your trading accountbalance in a run of terrible stoplossstrikes, Even thought the indicator saidBUY!The fact is;
Oscillator indicators in general, are risky and unreliable beasts.
They might look friendly and approachable at first, only to BITE your handoff just when you are most comfortable!
The RSI indicator is usually the go to oscillator for the novice trader whendeciding to enter that first trade.
There is a simple, valid reason for this;
The RSI indicator is simple to read and understand
and it “APPEARS” to get great results when given the visual back-test!
( Come on, admit it, we have all done it! We take a quick glance at the RSI indicator in search of that sweet confirmation bias when we are just itching to make a trade. )
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!It is almost impossible to resist the siren call of a trading signal from ourfavorite indicator.
But approaching trading in a passive fashion like this is dangerous and willlead to the destruction of your account eventually!
In this article I will teach you how to avoid some of the major pitfalls thatbeset most beginner traders when it comes to the RSI indicator.
I am going to show you a few important things:
I am going to break down the RSI indicator so you understand it from head to toe. I will explain the top 5 RSI trading strategies that we hear so much about, what they mean and how to trade using them. I will back test each of those strategies against the EURCHF over a 16 month period and see how they actually performed, using a sample starting account of $1000, and a sensible stoploss strategy.After reading this article you will Know the RSI indicator inside out,
AND;
YOU WILL BE better informed on the risks of using each of the RSI tradingstrategies to generate trading signals,
So;the next time the siren calls, you will think twice about placing that trade!
relative strength index calculation
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!These are the nitty gritty details on how the RSI indicator is built.
In reality your charting software will do this calculation for you, thats whattechnology is for!
1: Pick the base number of periods on which to base the study.
2: compare todays closing price with yesterdays.
3: add all the upward movements in points between closing prices.
4: add all the downwards movements between closing prices.
5: calculate the EMA ( exponential moving average ) of the upward anddownward price movements
6: calculate the relative strength,
RS = EMA Upward Price Movements / EMA Downward Price Move ments
7: Calculate the Relative Strength Index (RSI):
RSI = 1 / ( 1 + RS )
RSI definition, what does it all mean for my trading?
The RSI indicator Has definitely got one up over its competing oscillator inthe fact that it has fixed points extremes at 0 and 100.
Rather than the relative floating extremes of say the Momentum or Rate ofchange oscillators.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!In that sense it does give the trader a base to work from in judging one periodof market action to another.
The RSI indicator is also smoother than it’s big brothers, Because it usest h e Exponential moving average, it tends to be less jumpy and moreconsistent.
In general the RSI is interpreted as follows;
If the indicator is below 30, then the price action is considered weak andpossibly oversold.
If it is reading above 70, then the asset is after a strong uptrend and could beoverbought.
Because the RSI is used as a tool to indicate extremes in price action, then thetemptation is to use it to place contrarian trades,
Buying when the indicator crosses 30 to the upside means you are countingon the trend reversing and then profiting from it. The same is true for sellingwhen the RSI crosses down below 70 and using this a sign that the market isreversing from a strong uptrend.
Life is never that simple though, and more often than not, you will find thatthe risk involved in this type of simplistic approach is ruinous to you accountbalance.
New traders tend to gravitate to the RSI when attempting to delve intoanalysis for the first time.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!It is easy to aproach and easy to understand, it has fixed overbought andoversold levels and it tends to be correct over longer periods,
So;
I can see why it is so attractive to all of us,
However, you cannott ignore the hugh failings of the RSI indicator in a strongtrend!
It can stay at 90 for days on end,
dancing above the overbought line like it is on speed at a london rave in 1992!
This is no good to the novice trader who pressed the sell button withoutplacing a stop!
Some of us (like myself ) can only learn the hard way!
Here are some quick lessons:
Wait for conformation before considering a trade,
The RSI can remain at extreme levels for long periods in a strong trend
SO;
Dont jump right in when you see a reading of 90, first allow the RSI line tofall back below the overbought line to at least give a stoploss level to trade off.
Watch the Centreline for trend confirmtion.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!If the RSI line reaches an extreme and then returns to the centreline it is abetter indication of a turning point in the trend. Waiting for this to occur cancut out those nasty impulsive trades!
It is common for technical traders to watch the centreline to show shifts intrend,
If the RSI is above 50, then it is considered a bullish uptrend, and if its below50, then a bearish downtrend is in play.
Simple RSI strategy back test:
Over the last year of trading in EUR/CHF there has been:
5 overbought signals.
and
3 oversold signals.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!From the conventional viewpoint, this means the trader got 5 sell signals and3 buy signals.
Lets see how that worked out for him!
April 2015:the RSI indicator hit the 30 line to indicate an oversoldconditionThe trader uses this signal as an opportunity to buy the marketthissignal led to a 300 point rise without triggering a 50 point stop loss.that’s a300 point gain in your account!
July 2015:the RSI indicator hit the 70 line to indicate an overboughtcondition.The trader uses this signal as an opportunity to sell the market.thissignal led to a 150 point risethe market triggered a 50 point stop loss.that’s a50 point loss in your account!
August 2015:the RSI indicator hit the 70 line to indicate an overboughtcondition.The trader uses this signal as an opportunity to sell the market.thissignal led to a 400 point rise in the market!
the market triggered a 50 point stop loss.that’s a 50 point loss in youraccount!
January 2016:the RSI indicator hit the 70 line to indicate an overboughtcondition.The trader uses this signal as an opportunity to sell the market.thissignal led to a 150 point rise in the market!the market triggered a 50 pointstop loss.that’s another 50 point loss in your account!
January 2016:the RSI indicator hit the 70 line to indicate an overboughtcondition.The trader uses this signal as an opportunity to sell the market.thissignal led to a 250 point rise in the market!the market triggered a 50 pointstop loss.that’s another 50 point loss in your account!
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!March 2016:the RSI indicator hit the 30 line to indicate an oversoldcondition.The trader uses this signal as an opportunity to buy the market.thissignal led to a 220 point rise without triggering a 50 point stop loss.that’s a220 point gain in your account!
May 2016:the RSI indicator hit the 70 line to indicate an overboughtcondition.The trader uses this signal as an opportunity to sell the market.thissignal led to a 130 point rise in the market!the market triggered a 50 pointstop loss.that’s a 50 point loss in your account!
June 2016:the RSI indicator hit the 30 line to indicate an oversoldcondition.The trader uses this signal as an opportunity to buy the market.thissignal led to a 100 point declinewhile triggering a 50 point stop loss.that’s a50 point loss in your account!
In total the trader made 220 point gain in their trading account over 8 trades.
This was done with 2 winning trades and 6 loosing trades.
How to use rsi indicator in forex trading.
In order to get real value from the RSI indicator and take advantage of itsbenefits,
You need to approach it cautiously and interpret it a little deeper.
Here are a few techniques that you can use to cut out a lot of false signals.
Failure swings;As I mentioned above,
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!The problem faced by every trader who uses the RSI indicator is that themarket may well continue in its trend despite the fact that it hit an extremereading,
It might even go on to leave that price level behind in the distance dependingon the strength of the trend.
For this reason there came about the concept of the failure swing, in order tointerpret the index better.
There is both the bearish and bullish failure swing.
A ‘bearish failure swing’ happens when the RSI enters the overbought zone at70 and then comes back down below the 70 mark again.
In this case, a short position will be entered only after the RSI cuts downthrough the 70 line from the top.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!The ‘bullish failure swing’ occurs when the RSI enters the oversold zone at 30and then rallies out again and rises above the 30 line again.
The trader uses this rise above the 30 line as a trigger to go long.
Divergence:
Positive divergence happens when the price of an asset is drifting lower yetthe RSI is starting to trend higher.
This could mean that the price is nearing a bottom and will probably turn upsoon.
Negative divergence happens the opposite way, the price is driving higher, butthe RSI has stalled and is beginning to turn lower.
When this occurs it is likely that the price will stop rising soon after. Andthen follow the RSI lower.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!
Trend confirmation:The RSI can be useful as a tool for trend confirmation.
In a strong upward trending environment, the RSI rarely falls below 40, andwill most always stick to the 50 – 80 range.
The corollary is true for a downtrend.
In this case the range will below the centreline and spike into the lower endof the indicator.
Overbought and oversold indications:the standard settings for an overbought reading is 70 and for oversold it is 30.
this can be changed by the user to suit their own style.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!I generally look for the RSI to register several extreme readings in a rowbefore placing any great weight on the signals.
Centreline crossing:When the RSI crosses the centreline it is a stronger signal that a trend changehas happened than a simple extreme reading above or below the 70-30 lines.
When the indicator crosses the centreline to the upside, it means that theaverage gains are exceeding the average losses over the period.
The opposite is true for a downside cross.
When a centreline cross happens, it can be a good time to think about tradeentry on a fresh pullback in price.
RSI trendline breaks:RSI line itself can be interpreted by trendline analysis.
Its a simple trick but it is a useful analysis tool.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!
For example in an upward trending market,
Draw a line connecting the dips in the RSI line, if the RSI breaks thistrendline to the downside it is an early indicator of an impending change.
A break of the RSI trendline often precedes a break of the price trendline on aprice chart.
Relative strength index trading strategies
Compound RSI Strategies:A compound strategy is when you use two indicators together.
It is always advised to balance the signal of one indicator against another, thiswill help to cut out alot of false signals
There are a few indicators that pair well with the RSI and using themtogether can proved better trading signals.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results! RSI, candlestick strategy, RSI, MACD strategy, RSI, MA Cross strategy, RSI, Bollinger band strategy,All of the above trading strategies should always be used with a riskmanagement strategy alongside.
RSI, engulfing candlestick strategy:
In this trading strategy,
We combine the RSI indicator along with an engulfing candle stick.
This strategy will generate far less trades so you can afford to extend the stoploss position.
Only enter the market whenever the RSI gives an overbought or oversoldsignal which is supported by the a bullish or bearish engulfing candle.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!Close the position on a solid break of the opposite RSI line.
April 2015:The RSI indicator hit the 30 line to indicate an oversoldconditionThe trader uses this signal as an opportunity to buy the market
The trader waits to get an engulfing candle to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the nextdays trade.
this signal led to a 550 point rise without triggering a 100 point stoploss.that’s a 550 point gain in your account!
March 2016:The RSI indicator hit the 30 line to indicate an oversoldconditionThe trader uses this signal as an opportunity to buy the market
The trader waits to get an engulfing candle to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the nextdays trade.
this signal led to a 175 point rise without triggering a 100 point stoploss.that’s a total gain of 725 points in your account in two trades!
that’s a solid performance by any ones standard.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!
RSI + MACD:
In this trading strategy,
We combine the RSI indicator with the MACD.
First, enter the market whenever the RSI gives an overbought or oversoldsignal which is supported by a MACD signal line crossing.
And then close the position if either indicator provides an exit signal.
April 2015:The RSI indicator hit the 30 line to indicate an oversoldconditionThe trader uses this signal as an opportunity to buy the market
The trader waits for a signal line cross to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the nextdays trade.
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!this signal led to a 400 point gain without triggering a 50 point stop loss.
This combination indicator did not generate any further trades in the abovetime period.
RSI + MA Cross:
In this trading strategy,
we combine the RSI with the moving average crossover indicator.
We place a trade when the RSI gives an overbought or oversold signal whichis supported by a crossover of the moving averages.
Close the position on an RSI divergence.
Although this trading system came close, it did not generate any signals overthe 16 month time period!
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!I think we can count this one out as a useful trading system.
RSI Bollinger band:
In this trading strategy,
We combine the RSI indicator along with a Bollinger band squeeze.
First we wait for a Bollinger band squeeze to occur on a daily chart, thesqueeze should come to within 150 points or so.
Only enter the market whenever the RSI gives an overbought or oversoldfailure swing.
which is supported by a tag of the bands in the same direction.
Fro example:
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!A bullish signal happens when the rsi falls below 30 and then rises above 30again
Then a daily candle touches the upper Bollinger band. Close the position onan RSI divergence.
Again this trading system did not give any signal over the time period. We cancount out this system also!
So there you have it!Here are the results of the above back tests of the 5 trading systems;
Simple RSI strategy = In total this system made 220 point gain over 8 trades, 2 winning trades and 6 loosing trades. RSI, candlestick strategy = In total this system made 725 point gain over 2 trades, 2 winning trades and 0 loosing trades. RSI, MACD strategy = In total this system made 400 point gain over 1 trades, 1 winning trade and 0 loosing trades. RSI, MA Cross strategy = In total, this system made 0 trades and 0 points gained, RSI, Bollinger band strategy = In total, this system made 0 trades and 0 points gained,It is plain to see that the best system in this back test is the RSI candlestickstrategy. It did not give many trading signals but, when it did, They werefantastic signals.
And think about it;
RSI indicator trading strategy, 5 systems + back test results! RSI indicator trading strategy, 5 systems + back test results!The average hedge fund makes about 20% a year, with the very real risk ofloosing a whole lot! and what does the average savings account return?
The winning strategy above made about 100% ( depending on the $/pipamount / or lot size ) on your initial capital while risking about 10 – 15% oneach of the two trades.
That is some good food for thought!
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RSI indicator trading strategy, 5 systems + back test results!