Which RSI trading strategy is best?

The little-talked-about reality is that there is no one magic RSI strategy that works for everyone.

Yes, traders do use the RSI successfully. 

But the key is that they have all customized it to suit their personality and the market they trade. 

It can potentially be used in any trading market and it's a very flexible strategy that can be used in several different ways.

You have to review the RSI trading strategy options, pick a couple that make sense to you, then backtest them throughly to find out if each one has an edge.

If a strategy isn't profitable, you can experiment with the settings and inputs to see if you can make it profitable.

Even after you have a successful backtest, you can continue to work on optimizing the strategy to make it line up with your goals.

So in this article, I'm going to give you a list of all of the RSI trading strategies that I know about, so you can start this process for yourself. 

I'll also include some of my own backtesting results and give you links to RSI related resources that you can use to become a RSI expert.

Alright, if you're ready to become a RSI ninja, let's get into it.

RSI History and Calculation

Before I get into the actual strategies, if you're new to RSI trading, then take a minute to read about who invented it and how this indicator is calculated.

This may seem a little boring, but it's very important to understand the benefits and limitations of the RSI.

Knowing how RSI is calculated and what it tells you will allow you to get the most out of it. 

I've written a complete breakdown of the RSI here.

Now let's get into the actual strategies.

RSI Overbought/Oversold Trading Strategy

The traditional use of the RSI is to identify potential turning points on the market.

When the indicator goes oversold, that can mean that too many traders are short and the market is ready for a reversal.

On the other hand, when RSI is overbought that can mean that too many traders are long.

In other words, this is a countertrend trading strategy that looks to trade trend reversals.

Indicator Settings

The most commonly taught use of the RSI Overbought/Oversold Strategy uses the following settings:

• Periods: 14
• Levels: 70/30

Traders usually wait until RSI starts to form a peak or bottom out, before they sell or buy.

Trade Entry

Here's the most common entry:

• Sell: When the RSI peaks above 70
• Buy: When RSI peaks below 30

Short Example

When RSI enters the overbought signal level, you can wait for it to peak to take a short trade.

Long Example

In this example, price had a nice upside run after RSI went into oversold territory.

Of course, not all trades work out this well, but these are examples to illustrate the point.

If you are missing a lot of RSI signals, be sure to check out our standard RSI alert indicator for MT4.

Stop Loss and Take Profit

The stop loss is set above or below the last swing high/low.

A good take profit is the next support or resistance level, but you can experiment with different levels to see what works best for you.

Here's an example short trade.

Potential Improvements

You can (and should) backtest this strategy as-is.

But if you're looking for ways to optimize this strategy then I'm also going to give you methods to potentially to improve you results.

Remember that all improvements should be backtested and do not guarantee better results. 

They are just ideas that you can use to experiment with your strategy. 

Here are a few things that you can try:

• Take a trade as soon as RSI closes inside the signal levels
• Change the periods setting
• Only take trades when price is at clear support or resistance
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk

RSI Divergence Trading Strategy

Another way that you can use RSI is as a divergence indicator.

This means that if you spot RSI trending in the opposite direction of price, it's a possible signal that price is going to reverse.

To learn more about RSI Divergence, read this article.

Indicator Settings

The most commonly taught use of the RSI uses the following settings:

• Periods: 14
• Levels: 70/30

Trade Entry

Here's the most common entry:

• Sell: When price shows a second higher peak, but RSI shows a lower peak and the first peak is overbought
• Buy: When price shows a second lower peak, but RSI shows a higher peak and the first peak is oversold

Short Example

So in the chart above, the blue line on the chart shows the two price peaks going higher, while the RSI peaks are going lower.

This signals a possible reversal of the uptrend.

As you can see, price does drop from this point, but depending on your profit target, it may not have been enough to hit your profit target.

There are at least two other divergences on this chart.

Can you spot them?

These signals can be hard to spot, so it's very useful to have a RSI divergence indicator.

Long Example

Stop Loss and Take Profit

The stop loss usually goes above the second high for a short and below the second low for a long.

As far as the take profit, a good place to set it is the next support or resistance level.

Potential Improvements

Here are a few things that you can try:

• Change the periods setting
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk
• Take trades even when RSI doesn't go into overbought and oversold

RSI Exit Trading Strategy

As you know, when you get into a big trend, RSI can stay overbought or oversold for a long time.

This can lead to big losses if you continue to fight it and you don't have something like a 2-Strikes Rule.

So an alternative to entering a trade when RSI hits the signal level and starts to turn, is to enter the trade when RSI exits the signal level.

This may mean that you catch the entry late, but it makes it much less likely that you will be fighting a big trend.

Indicator Settings

The most commonly taught use of the RSI uses the following settings:

• Periods: 14
• Levels: 70/30

Traders usually wait until RSI starts to form a peak or bottom out, before they sell or buy.

Trade Entry

Here's the most common entry:

• Sell: When the RSI gets above 70, sell after RSI closes below the 70 level
• Buy: When RSI gets below 30, buy after RSI closes above the 30 level

Short Example

Long Example

Stop Loss and Take Profit

The stop loss for this strategy would go below the low for a long and above the high for a short.

Placing the take profit at the next support or resistance level is the best exit to start testing.

Potential Improvements

Here are a few improvements to this strategy you can experiment with:

• Change the periods setting
• Only take trades when price is at clear support or resistance
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk

Larry Connors RSI 2 Trading Strategy

Now we get into a really cool RSI trading technique.

This is the RSI 2 strategy by Larry Connors.

It's also a good example of using a complementary indicator with the RSI.

Basically, the RSI indicator is adjusted to a 2 period setting and the signal levels are moved to 95 and 5.

After that, we use a 200 EMA to determine if we should go long or short.

Above the EMA is long, below is short.

When price hits a RSI trading signal level and is in the right position, with respect to the 200 EMA, then you take a trade. You exit when price closes above (for a long) or below (for a short) a 5 EMA.

All of the long signals are marked in the chart above, with red vertical lines.

Obviously, this is a very short-term strategy.

Indicator Settings

The most commonly taught use of this method uses the following settings:

• RSI periods: 2
• RSI levels: 95/5
• Simple Moving Average: 200
• Simple Moving Average: 5

Trade Entry

• Sell: When RSI is overbought and price closes below the 200 SMA
• Buy: When RSI is oversold and price closes above the 200 SMA

Short Example

Long Example

Stop Loss and Take Profit

There are no stop losses with this strategy.

Connors found (as have I) that this strategy works best without stop losses.

The exit for this strategy is when price closes on the other side of the 5 SMA.

This strategy is more of a short term strategy that closes trades fairly quickly.

Potential Improvements

Here are a few improvements to this strategy you can experiment with:

• Change the periods setting
• Only take trades when price is at clear support or resistance
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk

Backtesting Results

You can also see my results of a backtest here.

RSI 50 Crossover Trading Strategy

The previous RSI trading methods rely on price extremes to find potential trading ideas.

Of course, trading at extremes can be a great way to get in for cheap.

However, you are also bucking the trend and that can mean that you might get stopped out a lot.

One way to possibly remedy this is to try to catch price when it is starting to trend.

For this strategy you set your levels both to 50, then enter a trade when RSI closes above or below the 50 level.

Indicator Settings

The most commonly taught use of the RSI uses the following settings:

• Periods: 14
• Set both levels to 50

Trade Entry

• Sell: When RSI has stayed above the 50 for awhile, go short when RSI closes below the 50 level
• Buy: When RSI has stayed below the 50 for awhile, go long when RSI closes above the 50 level

Short Example

Long Example

Stop Loss and Take Profit

The best place to set the stop would be above the last swing high for a short, or below the last swing low for a long.

Like with all of these strategies, a good place to start with the profit target at the next support or resistance level.

Potential Improvements

Here are a few improvements to this strategy you can experiment with:

• Change the periods setting
• Only take trades when price is bouncing off clear support or resistance
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk
• Look for reversal price action like a head and shoulders or double top/bottom before the crossover

Final Thoughts

So I hope that these RSI ideas have given you a few things that you can test.

Remember, there isn't one best way to trade the RSI.

You have to find the one that works best for you and the markets you trade. 

But sometimes you just need a few ideas to get your creative juices flowing.

The next step after reading this article is to start backtesting your RSI trading strategy.

Have fun!

The post RSI Trading Strategies Guide appeared first on Trading Heroes.

Wasssup, hope your trading is going well. As you probably know, all major financial markets are related, to varying degrees. Therefore, in order to understand how FX markets will move, you must also understand what is going on in bonds, indices and other markets.

Today, I'm happy to present some research from Troy Bombardia. He will show you why he thinks the U.S. Stock Market is due for a big correction, based on stock market corrections history. Troy is not the only one who believes this. Also keep an eye on pairs like EURJPY, which can be highly influenced by the S&P500.

So without further delay, here's Troy…

– Hugh

Note: In this post, the words “U.S. stock market” and “S&P 500” are interchangeable. I believe that the S&P 500 best reflects the state of the U.S. stock market. It is much broader than the Dow and is not as tech-focused as the NASDAQ.

The long term, multi-year movements of the U.S. stock market are not random. The S&P moves in clear cycles, which is why many large corrections are actually predictable.

People say that the crash of October 1987 came out of nowhere.

I disagree.

Here are my 2 favorite signals that can foretell many large corrections.

If the S&P Rises 80% Within 2 Years, Watch Out

Every time the S&P rises more than 80% in less than 2 years (504 trading days), a large correction ensues. Sometimes this signal comes out a little early, but by the end of the correction the S&P will be far lower than where it was when the signal came out.

This is a classic mean reversion signal. Whenever the stock market rises too quickly in too short an amount of time, it is “overbought” and must revert to its mean.

An 80% rise in less than 2 years is very difficult to achieve, which is why this signal has only come out 3 times in the past 50 years.

1. April 14, 2010 – This was only 8 days before a 17% correction began. This correction lasted 2 months.
2. March 20, 1998 – This was 4 months before a massive 22% correction began. This correction lasted 2.5 months.
3. August 7, 1987 – This was just a few days before a 33% correction began that culminated in the crash of October 19, 1987. This correction lasted 2.5 months.

The S&P Must Make a 10%+ Correction or a 4 Month Long Correction Within 3 Years, at Most

Like the previous mean reversion signal, the S&P has a time limit on how long it can rally without a “significant” correction. Some people define “significant correction” is a correction in which the S&P 500 falls more than 10%.

Defining “significant” this ways is nonsensical.

The purpose of a correction within a bull market is to washout some of the overbought momentum. A bull market cannot go up forever and ever without falling from time to time, so corrections are actually healthy for bull markets.

A correction that's “significant” enough to washout momentum does not have to be big percentage-wise. It can be big time-wise. That's why I define a “significant correction” as one that either falls more than 10% or falls for more than 4 months.

The last 10%+ correction ended in June 2012. From a historical standpoint, the S&P cannot go up for more than 3 years (750 trading days) without falling 10% or falling for more than 4 months.

Here's the Data

The S&P rallied for 3 years without a significant correction in only 2 other historical cases:

• From 1962 to 1965 – After this rally the S&P fell 11%
• From 2004 to 2007 – After this rally the S&P fell 12%

The current rally has lasted 3 years (as of mid-2015).

Thus, it's reasonable to expect a large or a long correction to begin any time now.

Conclusion

I am developing some other long term technical indicators that can help predict large corrections. All of these are based on some form of mean reversion.

For example, we all know that the stock market can get insanely overvalued, so valuation isn't really that useful. However, what I'm finding is that a lot of times the S&P will make a large correction when it reaches a minimum valuation target.

About the author: Troy Bombardia is an independent medium term trader who blogs over at Trading Slugger.

He uses long term technical indicators and medium term mean reversion indicators to trade stocks and commodities. He specifically focuses on the U.S. stock market and the precious metals markets.

The post How to Avoid Major U.S. Stock Market Corrections appeared first on Trading Heroes.