RSI (2) Follow Ups
Two follow ups to my recent post applying the RSI(2) indicator to the S&P 500.
First, a review of my last post: since the late 1990’s, when RSI(2) has fallen below 10/or risen above 90, it has portended bullish/bearish S&P 500 returns the next day. See graph below from 2000 of next day returns after RSI(2) fell below 10 (green) or rose above 90 (red).
[logarithmically-scaled]
Follow up #1: Other lookbacks periods
The first follow up comes from Damian of the quant-oriented Skill Analytics blog.
Damian looks at using shorter or longer lookback periods to calculate the RSI [i.e. RSI(1), RSI(3), RSI(4), etc], for both long and short trades. I recommend reading his post, but I’ll spoil the ending: applied using the very simple approach we’ve taken here, RSI(2) is the most predictive flavor of RSI.
Follow up #2: Other long/short thresholds
In my previous post, I used a threshold of “below 10” as bullish and “above 90” as bearish, but there’s nothing magical about those numbers. Below I’ve tested other bullish/bearish thresholds.
For a long position:
And for a short position:
As the above results show (especially for long positions) the deeper RSI(2) has gone into oversold (i.e. low) or overbought (high) territory, the more predictive it has become, but the less often it has triggered a trade.
Based on that observation, a better approach might be to scale positions in or out as the RSI goes further overbought/oversold. In a follow up post I’ll show the results of such a scaling strategy. I’ve run the numbers already and here’s a teaser, it’s good…dare I say, very good. More to follow.
[Edit: click for a summary of posts related to RSI(2)]
Happy Trading,
ms
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Filed under: Trading Strategies | 2 Comments
another good variation without using options would be to simply place limit orders “n” volatility units below the market as the RSI2 gets more extreme, this will reduce exposure, and increase gains per trade as well as significantly reduce drawdowns. so the same strategy, but once the RSI hits 15, you place a limit order say 2% below the market, then when it hits 10 you go 4% below the market, and if the RSI2 finally hits 5, you place an order to buy the SPY 6% below the market etc etc.
Whether you use limit orders or not would depend on where the VIX was on average over a 20-30 day period, the higher the VIX the more likely you should use limit orders and the larger these limits should be. I suspsect this may be one of the intermediate indicators you are referring to, i would use percentile rankings below an average with shorter lookbacks vs standard deviations to avoid “walking the band problems”.
dv