When the RSI-Indicator was sending the oversold signal, which position do you take either Long or Short?
When the RSI-Indicator was sending the overbought signal, which position do you take either Short or Long?
And, when the RSI-Indicator was sending the divergence(convergence) signal, which position do you take either Short or Long?
My answers of that simple questions are Short, Long, and Short(Long). Those are very simple questions about a RSI-Indicator. And it is this articles main theme. If we want to find out that answer, we should make a strategy and should be back-test it for getting some samples. But, it sounds tough? Actually, no, not at all. It is very easy for users of the Dukascopy's JForex platform. It’s designed for traders interested in automated trading and developing and testing trading strategies based on the JAVA programming language. So anybody can easily make the Strategies, Indicators, or Plugins, and test it. And important thing is that automated trading strategy can be used for not only daily trading but the simple research. But unfortunately this advantage have been often overlooked… Anyway, in this study, we going to answer the first questions by totally depend on that advantage.
What is RSI?
At first, we explains what is RSI. Wikipedia said,
The relative strength index (RSI) is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading period. The RSI is classified as a momentum oscillator, measuring the velocity and magnitude of directional price movements. Momentum is the rate of the rise or fall in price.By Wikipedia.
And, in this study, we use the Dukascopy’s default RSI-Inidicator which was setting period as 26.
Next, we explain briefly about trading rules of strategy which was using for getting sample data. It's a kind of the breakout trading strategy. Point is that it is a counter type strategy. When last bar's close price was hit the MinMax Line, then it take a position which is against the breakout direction. Period of MinMax Line is 26. Stop Loss is 0.5% of the entry price. Take Profit is 0.1% of the entry price. Check the chap.2 of this articles for more details.
All right then, let’s move onto the main subject of this study. Look at the right graph and the following table.
*Important: RSI values in this study are all adjusted to same direction. The RSI values of the Long position (orders which was breakout the min line) is already all inverted (100-RSI value). Simply put, it's almost same as absolute value of RSI - 50. So, 0 means no trend, 100 means overtrend (overheats).*
That table shows numbers of total orders per year. These values are arranged according to the RSI value. If you look at this distribution, it's clear there are some tendency. There are many orders which RSI value is between 50 and 70. Especially orders between 55 and 65 are so many. Look at the right graph, it is for 60% of the total orders. In contrast, number of orders which RSI value is more than equals to 80 are extremely low.
And the following table shows numbers of total gain pips per year.
But at this rate, it's little bit difficult to understand. So we transformed(total gain pips / number of total order) that value to average gain pips per 1 order. The table after dividing is as below.
Look at right graph. We did divide a previous table into 2 groups. Group A is contained the orders which RSI value is less than 65. Group B is contained the orders which RSI value is not less than 65.
You'll notice that, in this 11 years, eleven out of eleven, when RSI value was less than 65, counter strategy gained more pips than other group.
When the RSI-Indicator was sending the oversold signal, which position do you take either Long or Short? This study’s answer is Short, sell it more!
When the RSI-Indicator was sending the overbought signal, which position do you take either Short or Long? This study’s answer is Long, buy it more!
Basically, when the RSI send the signal of overheats, we should not take a position to the direction against the price trend. Please don't misunderstanding the messages from RSI indicator. His oversold signal is not the buy signal. Overbought signal is not the sell signal.
The RSI value of the opposite point has something meaning?
*Opposite point is opposite point of the break out point. In another words, trend-start point. E.g. Upper break's opposite position is that bar which has lowest close price of last 26 bars. Downer break's opposite position is that bar which has highest close price of last 26 bars.*
The table as below is numbers of total orders per year.
Of course these RSI values are adjusted to same direction. The RSI values of the short position (orders which was breakout the max line) is already all inverted (100-RSI value). And the following table is shown numbers of total gain pips per year.
And after transformed(total gain pips / number of total order) that value to average gain pips per 1 order is the right graph. It's shows average gain pips. Group A is contained the orders which RSI value is less than 50. Group B is contained the orders which RSI value is not less than 50. As you can see, anyway, it seems that when there aren't strong trend in the break point or the trend start point, counter strategy is better.
Divergence / Convergence
Next, we explain about trading result of divergence and convergence. What is Divergence or Convergence? Those signasl are means that the trend line of the RSI goes to the opposite direction to the trend line of the Price. That is, the situation is like this, in spite of the price trend expanding, the RSI's heat is decreasing.
Please look at the right graphs, the first one is image of the divergence situation. the RSI value goes down against upper trend of the price. We call this situation "Divergence".
On the other hand, look at the second graph, it is image of the convergence situation, The RSI value goes up against downer trend of the price. We call this situation "Convergence".
And, the criterion of Divergence and Convergence in this study is the following situation. The Price broke out the last 26 bars highest( lowest) value, but the RSI not succeeded to break the last 26 bars highest(lowest) value.
The following table explains stats of the NoDC (no divergence or convergence signaled) orders and the DC (divergence or convergence signaled) orders.
Look at the left graph. It's shows the both group's number of orders. Orders which with the signals are 31% of all orders. In my opinion, it was little bit bigger than I expected.
Next, please look at the right graph. It is shows the both group's average gain pips per 1 order. On this graph, you can see that group DC is more profitable than other in long term. So when the RSI-Indicator was sending the divergence(convergence) signal, we should take a position to against the price trend direction. Simply put, the divergence is sell-signal, the convergence is buy-signal.
Conversely, If you want to follow the price trend, you should wait the situations which there aren't divergence and convergence signal at breakpoint.
The RSI's diver/convergence signal of the opposite point has something meaning?
The following table shows result of the opposite point. Left block is the result of NoDC (no divergence or convergence signaled) orders, right block is the result of the DC (divergence or convergence signaled) orders.
From the right graph, we can read the following things. Divergence/Convergence signal of the opposite point is make counter strategy more profitable. In other words, the signal at breakpoint suggest the force for pushing back, but that power is very temporary. We shouldn't follow the trend when the opposite point sent the signal.
So I doubt the theory like right figures!!