Simple Indicator YTD Review: Scaling In & Out of RSI(2)
This is a multi-part series looking at how some of the simple indicators we’ve talked about in the past fared through this very interesting trading year.
Over the last decade, RSI(2) has become more predictive the deeper it’s travelled into overbought (high) or oversold (low) territory (read more), so I’ll assume a scaling approach: go 100% long the S&P 500 index at today’s close if RSI(2) closes below 5, 75% long on a close below 10, 50% below 15, and 25% below 20. Go 100% short on a close above 95, 75% above 90, 50% above 85, and 25% above 80.
Like our previous tests in this series, these results are frictionless (i.e. do not account for transaction costs/slippage), but could be very closely reproduced using actively-traded mutual funds (my weapon of choice). Unlike our previous test, I have not included return on cash.
Note that I have also not included a “long view” (prior to 2000) because, as we’ve talked about ad infinitum, these type of very short-term indicators worked in precisely the opposite way prior to the late 1990’s (read more).
After a decade of very consistent calls (see middle view) the RSI(2) indicator fell down badly in 2009, particularly when shorting against high readings. Put another way, when the indicator expected the market to pull back (“revert to the mean”) after making a strong short-term move up, the market has often continued higher.
We’re covering this breakdown in short-term mean-reversion in our monthly State of Short-term MR report. In a nutshell, I think (but do not know) that this is a temporary byproduct of this very, very bullish leg up in the markets and NOT an indication of things to come. And I still expect short-term MR to be the play du jour again once this market returns to some normalcy.
[Edit: click to read the rest of the YTD Review]
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