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.
In this post we look at blogosphere darling RSI(2), trading the S&P 500. Unfamiliar with this short-term indicator? Read our previous geekery here, here, and here.
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.
[growth of $10,000, logarithmically-scaled]
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).
YTD Performance
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]
Happy Trading,
ms
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Filed under: Trading Strategies | 4 Comments
What is the sell signal? Or is it 100% invested and just switches from long to short at extremes?
RE to Ruschem: the % allocation is explained in the post. It’s between 25% and 100% long/short depending on how “deep” RSI(2) travels towards extremes. Between 20 and 80 would be cash (0% allocation). Hope that helps. michael
Just a thought, but what if a filter was added that didn’t go short when the stock was above, say, its 100-day MA (and vice versa for buys)?
RE to BC: taking multiple timeframes into account will always improve results. That’s the idea behind our State of the Market report (http://marketsci.wordpress.com/state-of-the-market/) but these tests were all of the indicators in isolation.
Side note: you mentioned “stocks” in your comment. On this blog we focus on indexes (which can be traded with MFs, ETFs, etc) not individual stocks and I can’t say whether anything you find here is applicable to individual stocks.
michael