During a conversation with a private investor friend over a beer in the pub recently I stumbled across a new method for using RSI – or the Relative Strength Index as it is known by its full name.
This investor – who had won awards and was considered quite successful – told me that one of his strategies used the RSI on a 21 period setting.
This piqued my interest because RSI is normally used on a 14 period setting; “pray tell me more,” I said.
“RSI on a 21 setting works really well at telling you the direction of the trend,” he answered simply.
“If it is above 50 the asset is in an up-trend; if below 50 it is in a down-trend.”
Normally I was used to limiting my interest in RSI to whether it is trespassing on the overbought or oversold zone, however, the way Ben used the indicator was new and different.
He said he’d used the system to trade stocks profitably for years, buying on a cross above 50 and holding till it dipped below 50, before selling and holding till it went back above 50 again. The longer RSI setting also had the benefit of lowering the number of whipsaws, or false signals, by smoothing the results.
I love to try out novel strategies so I asked if I could test it and write the results up in an article, Ben said yes I could.
As he had used it on stocks I decided to test it on Forex.
I wrote a simple programme in metatrader (which is not as simple as it seems) with the help of an excellent book called “Easy Automated Trading: Simplified Coding for Metatrader 4,” and also the aid of its very helpful author Edward Munroe, who checked my code for me.
Eventually with Ed’s substantial input I managed to finish an automated programme of the RSI 21 strategy.
Next I decided to test it on EUR/USD, on a daily chart, with a hypothetical $10,000 account, the results are illustrated below:
Along the bottom are the trades and along vertical axis the equity. As can quickly be deduced from the graph, the strategy is profitable, but not amazingly profitable. In fact for a long period of time it was unprofitable before the sudden sharp gains after trade number 31.
If we dig a bit deeper into the results we might get a better idea of how well it works, I have presented the headline figures below:
The results show that from an initial deposit of $10,000 the strategy made $302.92 over a 740 day test period. This yielded a profit factor of 1.11. There were 46 trades in total, and maximum draw-down was 870.45.
The data tables above show that the strategy only had a 26.09% success rate – which is rather low, however, it did make up for this with a high average profit per trade of 263.60 compared to -84.13 for the average loser. The most profitable winner earned over 13% on the account, making 1330.81 – which is excellent for a one off win.
The strategy might also work better over a longer time period as 740 days is quite short. As Ed told me these sorts of trend-following strategies are successful over time but suffer in sideways markets.
Even the slow and relatively steady RSI(21) moved above and below the 50 line quite frequently at times making strings of false signals. One way he suggested of combating this was to incorporate another momentum indicator to help filter out more successful signals.
Hopefully in next month’s article we might look at how we can refine RSI21, by incorporating the use of another indicator or set of trading rules. Meanwhile I’d like to thank the investor Ben Tyler for sharing his strategy with me and Edward Munroe for helping me with the coding.