When I started trading, I learned one of the best indicator which is the Relative Strength Index. However, I did not know what should RSI be set at?
RSI should be set at two-period for short-term trading or 30 for momentum trading. Two-period is for three to five days swing trading while the 30 period is for high-speed momentum type. Depending upon your style, choose one or both.
- Set it to two period
- Set it to 30 period
- Set it to two-day cumulative period: Advance strategy
- Using a trading tool
The style of trading is usually important when selecting the settings of the Relative Strength Indicator.
Selecting a shorter period will help find trades which do not require over five day holding period. The holding period is not too long because the RSI is closely following the. price.
Unlike the 30-period, which often needs a lot of data to determine if there is actual strength in the market.
The strength is real because more data is important in this setting to avoid false momentum.
Because more data is a requirement, sometimes the trade entry is a bit late.
The default RSI setting is probably the most popular among new traders. They usually learn it through YouTube channels or from some online guru.
Because on YouTube, anyone can can become an expert, most people are teaching untested or unreliable trading strategies.
Their students or subscribes are usually losing money because the strategy becomes too popular.
When everybody is using the same strategy, no one will win in the long-run.
For example, the 14-period setting of RSI gradually lost its edge because too many people are using it.
The edge of the setting is now measurable through the use of a trading tool. For example, Amibroker.
Amibroker can back test any indicator setting, and it will show real statistics.
Using statistics can help improve your trading because there is an evidence that the setting is profitable.
However, the setting may not work on other securities, so it is important to keep testing a set-up.
Testing will help improve or upgrade a setting.
Set it to two-period
The two-period RSI is one improvement from the default setting. It is an improvement because the RSI indicator will now mirror the security’s price.
When the price is moving down and RSI2 is below five, it shows being oversold.
Oversold in technical term means it may be time to buy the security.
The security may increase in price within three to five days.
Within this period, a trader can monitor his positions if he has already taken the trade.
- 200MA filter to determine whether there is an uptrend or downtrend.
- Entry points: Buy when the RSI2 is below 5, and sell if above 95
- Exit Point: Base on trading style
Thanks to Larry Connors, this RSI2 setting is an improvement to the default setting of 14. He even added the 200MA filter, so that traders trade only up trending stocks.
Since we are looking for a buy trade, RSI2 is a good indicator to find good pullbacks.
Pullbacks are excellent entries when a trader wants to follow the uptrend. A trend is important to have a high probability of a successful trade.
Successful trades happen when we make it at the right time in up moving security.
Why I am recommending buy trades only? It’s because Shorting is not really a good idea although it was part of the video above.
Shorting securities, especially stocks, increase the trade risk because of going against a company.
What if a company is doing well, and buyers of the stock will come in? What will you do?
Set it to two-day cumulative period
Another strategy is the cumulative 2 Period RSI. It a strategy that combines the two days RSI and see if it is below five.
The combination is an advance strategy, and it uses the extreme oversold level of a security.
An extreme oversold level is a technical term in mean reversion strategy meaning that it is a high probability time to buy.
However, being high probability does not mean that the trade signal will have a 100% win rate.
Because the win rate is not 100%, we need to add the exit rules.
The exit rule used in the above video is the value of 65. When the value crosses 65, the trade is immediately closed.
Set it to 30-period
Another setting is the 30-period RSI. This setting allows time for traders to decide whether a security or stock shows price strength.
The strength is active if after 30 days the RSI has just crossed 70 level of the RSI indicator.
The RSI indicator, with a setting of 30, requires a lot of data to measure truly the speed of the uptrend move. It is under the premise that a strong security remains strong unless there is a change in direction.
You can find this strategy by searching the “Spyfrat Strategy”.
Summary of the strategy:
- Buy when the RSI30 crosses the 70 level; Weekly RSI30 is above 70.
- Sell when RSI 30 is above 80 or break down 70 level.
Using a Trading Tool and Back-testing
I use Amibroker to back test any trading strategy to know its reliability. I have tested a lot of RSI settings over the years, and I found out that two and 30 are good.
However, for some securities, it does not work, so I recommend to always test the setting before making any trade.
Testing will help traders avoid more losses because most securities have atypical behavior.
The unique characteristic of a particular stock differ from the others.
Because it differs, no RSI setting works all the time.
To find which setting is best, use a back tester to know what is the best setting.
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