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Relative Strength Index (RSI) Guide 2019

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Troy
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Summary:
Relative Strength Index, more commonly known as RSI is a very popular momentum indicator. It is often used as a contrarian indicator by traders. RSI becomes “oversold” when the market falls a lot RSI becomes “overbought” when the market rises a lot A lot of traders use RSI to predict the bottom and top of a market. You may have wondered “does RSI actually work when trading”? A lot of trading gurus claim that this “works”, but they only show you the cases when it works and they don’t show you the cases when it doesn’t work. In this post we’re going to look at What is RSI How traders commonly use RSI Problems with RSI (from a logical perspective) How well does RSI actually work (looking at the COMPLETE data & facts) Instead of reading this post, you can just watch the video

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Relative Strength Index, more commonly known as RSI is a very popular momentum indicator. It is often used as a contrarian indicator by traders.

  1. RSI becomes “oversold” when the market falls a lot
  2. RSI becomes “overbought” when the market rises a lot
  3. A lot of traders use RSI to predict the bottom and top of a market.

You may have wondered “does RSI actually work when trading”? A lot of trading gurus claim that this “works”, but they only show you the cases when it works and they don’t show you the cases when it doesn’t work.

In this post we’re going to look at

  1. What is RSI
  2. How traders commonly use RSI
  3. Problems with RSI (from a logical perspective)
  4. How well does RSI actually work (looking at the COMPLETE data & facts)

Instead of reading this post, you can just watch the video below.

What is RSI (Relative Strength Index)

Here is what RSI looks like on a daily chart of the S&P 500.

Relative Strength Index (RSI) Guide 2019

RSI is a momentum indicator that measures “how much” the market is going up and down, relative to its recent price changes.

  1. When the market goes up “a lot”, RSI goes up and becomes “high”. Hence the market is “overbought”.
  2. When the market goes down “a lot”, RSI goes down and becomes “low”. Hence the market is “oversold”.

RSI is by definition bound between 0 to 100. It cannot go below 0, and it cannot go above 100.

  1. The more the market goes up, the closer RSI gets to 100. Hence the market becomes more “overbought”
  2. The more the market goes down, the closer RSI gets to 0. Hence the market becomes more “oversold

Relative Strength Index (RSI) Guide 2019

RSI can be applied to any time frame. Traders use RSI on minute charts, hourly charts, daily charts, weekly charts, monthly charts, etc. We’re going to use daily RSI for this post.

In terms of settings, you can use anything. The most common setting is “14 daily RSI”.

  1. Other traders use 9 daily RSI. Since the 9 daily RSI uses fewer days, it is more “responsive” to the market’s daily price changes. Hence this RSI fluctuates more.
  2. Other traders use the 21 day RSI. Since the 21 daily RSI uses more days, it is less “responsive” to the market’s daily price changes. Hence this RSI fluctuates less.

We’re going to use the 14 daily RSI for this post.

If you want to know how to calculate RSI in excel, see my video here. Otherwise, skip this video and keep reading.

  1. So what RSI # counts as “oversold”?
  2. What RSI # counts as “overbought”?

The problem with this question is that the words “oversold” and “overbought” carry a subtle connotation with them.

  1. When many traders hear the word “oversold”, they automatically think “the market has gone down ‘too much’, it must go up soon”.
  2. When many traders hear the word “overbought”, they automatically think “the market has gone up ‘too much’, it must go down soon”.

Hence, asking “what RSI counts as oversold” and “what RSI counts as overbought” is essentially asking “at what level of RSI will the market stop falling, and at what level of RSI will the market stop rising”. This is true of any contrarian indicator, including RSI.

The common belief is that

  1. When RSI falls to 30 or less, the market becomes “oversold”. The more RSI falls below 30, the more the market becomes oversold.
  2. When RSI rises to 70 or more, the market becomes “overbought”. The more RSI rises above 70, the more the market becomes overbought.

In fact, this is what a lot of charting software like StockCharts, TradingView, your broker etc show you.

Here’s an example with StockCharts. You can see how they automatically define “oversold” as 30 and “overbought” as 70.

Relative Strength Index (RSI) Guide 2019

Here’s the first secret to using RSI indicator. There IS NO clear line in the sand that defines “overbought” and “oversold”. There’s no such thing as “RSI at 69 is not overbought because it’s under 70” and “RSI at 71 is overbought because it’s above 70”.

In fact, a lot of traders don’t use 30 and 70 to define oversold and overbought. In more volatile markets such as gold and silver, traders will often use 20 and 80.

The RSI level that defines “overbought” and “oversold” varies from market to market.

Here’s the second secret to using the Relative Strength Index Indicator. What counts as “oversold” in 1 market is not oversold in another market. What counts as “overbought” in 1 market is not overbought in another market. You CANNOT use the same RSI signals for every time frame across every market. You need to look at each market individually.

Here’s an example.

  1. If the S&P 500’s RSI falls to 30, the market will often bounce because it is “too oversold”
  2. If silver’s RSI falls to 30, silver will often keep going down because silver’s RSI tends to bottom out at 15-20.
  3. If the S&P 500’s RSI rises to 70, the market will often pullback because it is “too overbought”
  4. If silver’s RSI rises to 70, silver will often keep going up

Relative Strength Index (RSI) Guide 2019

For now, focus on the concept of “overbought” and “oversold”. Don’t focus on the parameters. I’ll get to that later when I show you EXACTLY how well RSI works for various markets.

To see how well RSI works, we’re going to test RSI strategy on the S&P 500, gold, and the U.S. Dollar Index in this post. You can run RSI backtests on all markets, but since we don’t want this post to be too long, we’re going to stick to 3 markets in this post.

  1. 1 stock market (S&P 500)
  2. 1 commodity market (gold)
  3. 1 currency index (U.S. Dollar Index heavily leans towards the EURUSD pair).

For now, here is how often various 14 daily RSI readings appear for the S&P, gold, and U.S. Dollar Index

S&P 500

This is for the S&P, from 1950-2018

Relative Strength Index (RSI) Guide 2019

Gold

This is for gold, from 1970-2018

Relative Strength Index (RSI) Guide 2019

U.S. Dollar Index

This is for the U.S. Dollar Index, from 1983-2018

Relative Strength Index (RSI) Guide 2019

Now you know how common various RSI readings are for various markets. As expected, the most common readings are in the 40-60 range, which means that RSI (a momentum indicator) is neither overbought or oversold.

Next, let’s look at how traders commonly use RSI

How can you use the Relative Strength Index to trade

There are 4 main ways of using RSI to trade:

  1. Overbought/oversold
  2. RSI divergence
  3. RSI trendlines and trendline breaking
  4. As a trend following strategy (e.g. above and below 50)

The first 2 methods are contrarian strategies. Since RSI was designed as a contrarian indicator, the first 2 methods are more popular.

The last 2 methods are trend following strategies. They are less well known, because this essentially turns RSI (a contrarian indicator) into a trend following indicator.

Let’s look at each of these 4 ways of using RSI for trading.

Overbought and oversold

In this strategy:

  1. You turn bullish (and potentially buy) when the market is oversold
  2. You turn bearish (and potentially sell) when the market is overbought

Here’s a classic example with gold. You turn bullish and go long gold when its 14 daily RSI falls to 30. This successfully catches the bottom.

Relative Strength Index (RSI) Guide 2019

Here’s a classic example with the U.S. Dollar Index. You turn bearish and go short the USD when its 14 daily RSI  indicator rises to 70. This successfully catches the top.

Relative Strength Index (RSI) Guide 2019

In the next part of this post we’ll look at why using RSI as an oversold and overbought contrarian indicator can be problematic. For now, we’ll move onto the next method for using RSI as a trading indicator.

RSI divergences

In most cases RSI will move in the same direction as the overall market. This means that:

  1. When the market goes up, RSI (momentum indicator) usually goes up
  2. When the market goes down, RSI (momentum indicator) usually goes down

However, this doesn’t always happen. When it doesn’t happen, it’s called a “divergence”. The 2 types of divergences – “bullish divergences” and “bearish divergences” – are used as contrarian signs.

A bullish divergence occurs when the market makes a lower low, but RSI makes a higher low. Here’s an example with the S&P’s 14 weekly RSI from 2008-2009.

Relative Strength Index (RSI) Guide 2019

A bearish divergence occurs when the market makes a higher high, but RSI makes a lower high. Here’s an example with the S&P’s 14 weekly RSI from 2006-2007.

Relative Strength Index (RSI) Guide 2019

You’ve probably heard of RSI divergences before, but have you ever thought about WHY RSI divergences are considered to be contrarian signs?

As an indicator, RSI measures the market’s momentum. At the same time, RSI is upper-bound at 100 and lower-bound at 0.

  1. When the market keeps going up but RSI makes lower highs (bearish RSI divergence), it means that the PACE of the market’s rally is slowing down. The rally becomes more choppy than it used to be. In other words, the market could potentially roll over
  2. When the market keeps going down but RSI makes higher lows (bullish RSI divergence), it means that the PACE of the market’s decline is slowing down. The decline becomes more choppy than it used to be. The market could potentially roll up.

Here’s the same example with the S&P in 2008-2009.

Relative Strength Index (RSI) Guide 2019

Relative Strength Index (RSI) Guide 2019

Here’s the same example with the S&P in 2006-2007.

Relative Strength Index (RSI) Guide 2019

Relative Strength Index (RSI) Guide 2019

In short, RSI divergences are based on the idea that the market “rolls over”. This is a concept often used elsewhere in trading, such as Wyckoff market cycles.

Relative Strength Index (RSI) Guide 2019

RSI trendlines

Most traders are taught

  1. “Be bullish when the market falls to support level”
  2. “Be bearish when the market rallies to resistance level”
  3. “Be bearish when the market breaks below a support level”
  4. “Be bullish when the market breaks above a resistance level”

What most traders don’t know is that you can use RSI the exact same way:

  1. “Be bullish when the market’s RSI falls to support”
  2. “Be bearish when the market’s RSI breaks below a support”
  3. “Be bearish when the market’s RSI rallies to resistance”
  4. “Be bullish when the market’s RSI breaks above a resistance”

Be bullish when the market’s RSI falls to support

Here’s an example with the S&P 500

Relative Strength Index (RSI) Guide 2019

Be bearish when the market’s RSI breaks below a support

Here’s an example with the S&P 500

Relative Strength Index (RSI) Guide 2019

Be bearish when the market’s RSI rallies to resistance

Relative Strength Index (RSI) Guide 2019

Be bullish when the market’s RSI breaks above resistance

Here’s an example with the S&P 500

Relative Strength Index (RSI) Guide 2019

Use RSI as a trend following strategy

Lastly, you can use RSI as a trend following strategy. For example, you can buy the S&P 500 when its weekly RSI is above 50 and sell the S&P when its weekly RSI is below 50

In the following chart, you can clearly see that it’s better to buy the S&P when its weekly RSI is above 50 vs. when its weekly RSI is below 50.

Relative Strength Index (RSI) Guide 2019

Problems with Relative Strength Index (RSI), from a logical perspective

I’ve explained 4 ways of using RSI:

  1. Overbought/oversold
  2. RSI divergence
  3. RSI trendlines and trendline breaking
  4. As a trend following strategy (e.g. above and below 50)

Before we use data to look at exactly how well RSI actually works, we must first understand the problems with RSI. The trading gurus won’t do this. They only cherry pick the cases in which XYZ indicator works, but they don’t show you the cases in which it doesn’t work.

To truly understand how well an indicator works, we must look at the sum of its successes AND failures. Forget about the “it looks like this indicator works” BS. “Looks like” is not analysis. It’s guessing.

Problems with overbought and oversold

  1. When a lot of traders think of the word “overbought”, they automatically assume that the market can’t keep going up and that it’s time to turn bearish
  2. When a lot of traders think of the world “oversold”, they automatically assume that the market can’t keep going down and that it’s time to turn bullish

This doesn’t always work

  1. When the market is “extremely overbought”, it can keep going up. “Eventually” the market will fall, but it might first rally e.g. +10% before falling -5%
  2. When the market is “extremely oversold”, it can keep going down. “Eventually” the market will rally, but it might first fall e.g. -10% before rallying +5%

When the market keeps going up despite being “overbought”, we refer to it as “overbought can become even more overbought”. Here’s an example with gold in 2009

Relative Strength Index (RSI) Guide 2019

You can see that the 1st time you sell because RSI is overbought, you successfully timed the market. The 2nd time you sell because RSI is overbought, the market keeps rallying. The market “eventually” falls, but RSI failed as a timing indicator. It did not predict the top.

When the market keeps going down despite being “oversold”, we refer to it as “oversold can become even more oversold”. Here’s an example

Relative Strength Index (RSI) Guide 2019

You can see that the 1st time you buy because RSI is oversold, you successfully timed the market. The 2nd time you buy because RSI is oversold, the market keeps falling. The market “eventually” bounces, but RSI failed as a timing indicator. It did not predict the bottom.

Problem with RSI divergences

There are 2 big problems with RSI divergences:

  1. What counts as a “divergence”?
  2. A “divergence” can last for a very long time, to the point that it’s useless as a timing indicator.

What counts as a divergence

According to standard technical analysis, a “divergence” occurs when the market and its RSI move in different directions. The problem is that the market always “looks like” it’s making an RSI divergence, unless the current RSI is the most extreme it’s ever been. It can always “look like” a divergence, as long as you find an extremely high RSI reading in the past and use it as your starting value.

Here’s an example with the S&P in 2013.

Relative Strength Index (RSI) Guide 2019

The problem with RSI “divergences” is that it becomes a weird form of circular logic. Here’s an often repeated line from permabears

  1. “RSI is making a divergence right now! The stock market is going to crash!!!!”
  2. The only way for RSI to not make a divergence is if RSI becomes even higher. But if RSI becomes even higher, the same permabears will say “RSI is too high! The market is going to crash!”

You can see how this makes no sense. It’s like saying:

  1. The market isn’t going up enough! The stock market is going to crash!!!
  2. The market has gone up too much! The stock market is going to crash!!!

Whether or not the market reverses is not BECAUSE of it made a divergence. That’s like betting on a sports game by flipping a coin, and during the 50% of times when you’re right, saying “see! I told you flipping a coin works!”

As objective traders, we need to consider how many times something does work and how many times it doesn’t work. RSI divergences “work” – 50% of the time.

A divergence can last for a very long time, to the point that it’s useless as a timing indicator

Here’s a daily RSI example with the S&P in 2017.

Relative Strength Index (RSI) Guide 2019

Here’s a monthly RSI example with the S&P from 1996-2000. You can see how there was a massive “bearish divergence” from 1996-2000. “Eventually” the market crashed from 2000-2002

Relative Strength Index (RSI) Guide 2019

Relative Strength Index (RSI) Guide 2019

So why is this useless as a timing indicator?

  1. Because the market was making a “bearish divergence” from 1996-1997. It kept going up another 3 years
  2. Because the market was making a “bearish divergence” from 1996-1998. It kept going up another 2 years
  3. Because the market was making a “bearish divergence” from 1996-1999. It kept going up another 1 year

If a “market timing indicator” predicts that the market will reverse, and the market doesn’t reverse for 3+ years, then the indicator is useless. You might as well flip a coin.

Trading gurus show you when a divergence successfully predicted a market reversal, but they don’t show you when a divergence failed at predicting a reversal. That’s like only showing you the 50% of cases when flipping a coin successfully predicted the markets, and then claiming that “flipping a coin WORKS!!!”

Problems with RSI trendlines

RSI trendlines have the same problem as all trendlines in general: what exactly counts as a “trendline”?

Trendlines are extremely imprecise. Connect 2 different points, and you get a different trendline.

Here’s an example with the S&P.

Relative Strength Index (RSI) Guide 2019

Notice that in the above chart, RSI’s “trendline” was broken?

You can redraw the same chart with a different RSI trendline to demonstrate that its RSI trendline isn’t broken.

Relative Strength Index (RSI) Guide 2019

Here’s the problem with trendlines:

  1. All market breakdowns involve falling below a trendline.
  2. Not all broken trendlines result in the market falling even more (i.e. false breakdown)
  3. All market rallies involve rising above a trendline.
  4. Not all broken trendlines result in the market rallying even more (i.e. false break out).

So what do most traders do when their trendlines fail? They redraw it. Which is to say that trendlines (including RSI trendlines) work terrifically with 20/20 hindsight, but are no better than a coin toss in real time.

Trendlines are imprecise. So for the purposes of our backtesting, we are going to ignore them.

Problems with RSI as a trend following strategy

Using RSI in a trend following strategy usually results in underperformance.

*This is particularly true in the stock market.

We already looked at what happens if you buy the S&P 500 when its weekly RSI is above 50 and sell the S&P when its weekly RSI is below 50

Relative Strength Index (RSI) Guide 2019

While it’s better to buy when weekly RSI is > 50 than when weekly RSI is <50, you can see that this strategy does not beat buy and hold

How well does RSI actually work?

So how well does RSI actually work? A lot of indicators “look like” they work when you stare at a chart, but your eyes tend to see whatever they want to see when staring at a chart.

That’s why we use data instead of eyeballing a chart. No guessing, no recency bias.

Keep in mind that no indicator is perfect, including RSI. But what we want to know is:

Does RSI work any more than random (e.g. tossing a coin)?

Or is this just another popular indicator that works: 50% of the time?

For our test, we’re going to look at what happens next to the S&P, gold, and U.S. Dollar Index when RSI rises above various readings and falls below various readings.

First, here’s the random probability of the S&P, gold, and U.S. Dollar going up and their average returns.

For the S&P 500:

Relative Strength Index (RSI) Guide 2019

For gold:

Relative Strength Index (RSI) Guide 2019

For the U.S. Dollar Index

Relative Strength Index (RSI) Guide 2019

Now let’s look at how useful RSI is for predicting market tops and bottoms. We’re going to calculate the forward returns for the S&P, gold, and the U.S. Dollar Index when their 14 day RSI’s are within certain ranges:

  1. Above 80
  2. 70 to 80
  3. 60 to 70
  4. 30 to 40
  5. 20-30
  6. Below 20

Then we’re going to compare this against “random”, as defined above.

How useful is Relative Strength Index (RSI) for predicting the S&P 500’s tops and bottoms

Once again, here’s “random”:

Relative Strength Index (RSI) Guide 2019

For Overbought

Overbought (14 daily RSI > 80)

This RSI reading has occurred on 149 historical days

Returns (when RSI was >80):

Relative Strength Index (RSI) Guide 2019

% difference from “random” (when RSI was >80):

Relative Strength Index (RSI) Guide 2019

Overbought (14 daily RSI > 70 and <= 80)

This RSI reading has occurred on 1742 historical days

Returns (when RSI was >70 and <= 80):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >70 and <= 80):

Relative Strength Index (RSI) Guide 2019

Overbought (14 daily RSI > 60 and <= 70)

This RSI reading occurred on 4024 historical days

Returns (when RSI was >60 and <= 70):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >60 and <= 70):

Relative Strength Index (RSI) Guide 2019

For Oversold

Oversold (14 daily RSI > 0 and <= 20)

This RSI reading occurred on 52 historical days

Returns (when RSI was <= 20):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was <= 20):

Relative Strength Index (RSI) Guide 2019

Oversold (14 daily RSI > 20 and <= 30)

This RSI reading occurred on 563 historical days

Returns (when RSI was >20 and <= 30):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >20 and <= 30):

Relative Strength Index (RSI) Guide 2019

Oversold (14 daily RSI > 30 and <= 40)

This RSI reading occurred on 2020 historical days

Returns (when RSI was > 30 and <=40):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was > 30 and <=40):

Relative Strength Index (RSI) Guide 2019

Conclusion for the S&P 500’s Relative Strength Index (RSI)

There are several takeaways:

  1. When RSI is extremely high (e.g. >80), the S&P’s forward returns are more bearish than “random”
  2. When RSI is high, but not extremely high (e.g. 70 – 80), the S&P’s forward returns are more bullish than “random”. High RSI implies that the S&P is in an uptrend
  3. When RSI is extremely low (e.g. < 20), the S&P’s SHORT TERM forward returns are more bullish than random
  4. Otherwise, oversold RSI readings don’t mean much for the S&P’s forward returns. Sometimes the S&P keeps falling when RSI is low, and sometimes the S&P rallies when RSI is low.

Relative Strength Index (RSI) Guide 2019

How useful is Relative Strength Index (RSI) for predicting gold’s tops and bottoms

Once again, here’s “random”:

Relative Strength Index (RSI) Guide 2019

For Overbought

Overbought (14 daily RSI > 80)

This RSI reading has occurred on 160 historical days

Returns (when RSI was >80):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >80):

Relative Strength Index (RSI) Guide 2019

Overbought (14 daily RSI > 70 and <= 80)

This RSI reading has occurred on 824 historical days

Returns (when RSI was >70 and <= 80):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >70 and <= 80):

Relative Strength Index (RSI) Guide 2019

Overbought (14 daily RSI > 60 and <= 70)

This RSI reading occurred on 1948 historical days

Returns (when RSI was >60 and <= 70):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >60 and <= 70):

Relative Strength Index (RSI) Guide 2019

Relative Strength Index (RSI) Guide 2019

Oversold (14 daily RSI <= 20)

This RSI reading occurred on 41 historical days

Returns (when RSI was <= 20):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was <= 20):

Relative Strength Index (RSI) Guide 2019

Oversold (14 daily RSI > 20 and <= 30)

This RSI reading occurred on 428 historical days

Returns (when RSI was >20 and <= 30):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >20 and <= 30):

Relative Strength Index (RSI) Guide 2019

Oversold (14 daily RSI > 30 and <= 40)

This RSI reading occurred on 1712 historical days

Returns (when RSI was > 30 and <=40):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was > 30 and <=40):

Relative Strength Index (RSI) Guide 2019

Conclusion for gold’s Relative Strength (RSI) Index

There are several takeaways:

  1. Very high RSI readings are not consistently bearish for gold
  2. Somewhat high RSI readings for gold (e.g. 60-80) are slightly more bullish for gold than “random”.
  3. Low RSI readings are short term bullish for gold, but more long term bearish. Gold will often bounce and then keep falling, thereby creating a divergence with RSI.

In other words, there is some validity to using RSI as a trend following indicator for gold.

Relative Strength Index (RSI) Guide 2019

How useful is RSI for predicting the U.S. Dollar Index’s tops and bottoms

Once again, here’s “random”:

Relative Strength Index (RSI) Guide 2019

Overbought (14 daily RSI > 80)

This RSI reading has occurred on 70 historical days

Returns (when RSI was >80):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >80):

Relative Strength Index (RSI) Guide 2019

Overbought (14 daily RSI > 70 and <= 80)

This RSI reading has occurred on 4074 historical days

Returns (when RSI was >70 and <= 80):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >70 and <= 80):

Relative Strength Index (RSI) Guide 2019

Overbought (14 daily RSI > 60 and <= 70)

This RSI reading occurred on 1443 historical days

Returns (when RSI was >60 and <= 70):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >60 and <= 70):

Relative Strength Index (RSI) Guide 2019

For Oversold

Oversold (14 daily RSI <= 20)

This RSI reading occurred on 31 historical days

Returns (when RSI was <= 20):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was <= 20):

Relative Strength Index (RSI) Guide 2019

Oversold (14 daily RSI > 20 and <= 30)

This RSI reading occurred on 520 historical days

Returns (when RSI was >20 and <= 30):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was >20 and <= 30):

Relative Strength Index (RSI) Guide 2019

Oversold (14 daily RSI > 30 and <= 40)

This RSI reading occurred on 1516 historical days

Returns (when RSI was > 30 and <=40):

Relative Strength Index (RSI) Guide 2019

% difference from random (when RSI was > 30 and <=40):

Relative Strength Index (RSI) Guide 2019

Conclusion for the U.S. Dollar Index’s Relative Strength Index

There are several takeaways:

  1. Very high RSI readings are short term bearish for the USD (mean reversion), but long term bullish. When RSI is very high, the USD will often pullback and then go higher. Very high RSI readings often occur during USD bull markets
  2. Somewhat high RSI readings (e.g. 70-80) are more bullish than “random” for the USD
  3. Low RSI readings are short term bullish for the USD gold, but long term bearish. The USD will often bounce and then keep falling, thereby creating a divergence with RSI.
  4. Somewhat low RSI readings (e.g. 20-30) are more bearish than “random” for the USD

In other words, there is some validity to using RSI as a trend following indicator.

Relative Strength Index (RSI) Guide 2019

Overall conclusion

In summary:

Relative Strength Index (RSI) Guide 2019

You can see some common themes:

  1. When RSI is somewhat overbought (e.g. 60-70), the market is more bullish than random. This is because RSI readings of 60-70 often coincide with bull market rallies
  2. Very high RSI readings are rare. They are short term bearish. But sometimes, they can also be long term bullish. High RSI usually occurs in a bull market: the market pulls back and RSI falls, then the market makes new highs
  3. Very low RSI readings are rare. They are short term bullish. But sometimes, they can also be long term bearish. High RSI usually occurs in a bear market: the market bounces and RSI rises, then the market makes new lows

Overall, RSI is not a holy grail for trading. It gives traders a slight edge in the markets, but when you add up the number of failures, this isn’t a huge edge. As objective traders, we need to look at the number of times something “works” AND the number of times something doesn’t work. That’s what we did in this post.

Click here if you’re interested in learning about trading strategies and trading models that beat buy and hold!

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