Technical Indicators 101 (RSI)
The RSI is a common indicator, short for the relative strength index. It measures momentum looking at how large the recent price moves have been to look for reversals. It is on a scale of 0 to 100. An RSI of over 70 indicates that a stock is overbought and an RSI of under 30 indicates a stock is oversold. An increasing RSI indicates momentum upwards and a decreasing RSI indicates momentum downward. Many use the RSI, and other technical indicators for trading, however some traders do not think these indicators hold merit.
To determine which side I should be on, and to determine if the Invstr community should use these indicators, I tested buying based on these indicators historically. Taking 20 years S&P 500 data I tested the RSI by buying when the RSI was less than 30, and shorting when the RSI was over 70. Specifically, if the RSI trigger was hit, you would buy/short at the closing price, and you would close your position 24 hours later. In practice, this cannot be done reliably but for the purposes of this test, it is an ok approximation. The results were fairly good, 51% of the time the return is positive, the average positive return is .82%, and the average negative return is -.65%.
Another method I tested had better results. Again you would be buying when the RSI was less than 30, and shorting when the RSI was over 70. The difference was that you would not close your position until the RSI exited the oversold or overbought range. For example if the RSI on day 1 is 35, day 2 is 29, day 3 is 28, day 4 is 35, you would enter at the close of day 2 and exit on the close of day 4. This method had gains 54% of the time, had an average gain of 1.29%, and an average loss of .98%. This shows in practice a reversal of the RSI is a strong indicator, but it should not be the only factor you trade on.
Invstr provides charting like the RSI, which I and many others in the community rely on. To access this charting, click on a stock, go to “chart”, and click “technicals” in the bottom left. There you can tap on the middle of the three buttons in the top left, then click on relative strength indicator. After this analysis it is clear the RSI has merit, but should not be all you use to trade. Disclaimer: understand the risks before you trade and only trade what you can afford to lose. This is not investment advice only one person’s opinion.
Follow my Invstr page @robbieb for more analysis!