This is also an extremely simple strategy where we follow the RSI indicator (e.g. 14-day RSI). When the price becomes lower than some “oversold” value, we buy the stock. We sell it when the price reaches an “overbought” level.
This is illustrated in the graph below:
Of course, a low RSI does not guarantee that the price has reached a bottom, as well as a high RSI does not mean that the price will not continue to increase. Therefore, we can try to modify this simple strategy a bit: we buy a stock as soon as the 14-day RSI crosses the value 20 from below (i.e. it begins to increase again). We sell the stock as soon as RSI touches 70.
We do not use any stop-losses, i.e. what I show is not a real trading strategy. We rather try to simulate the “power” of the RSI-indicator.
At first, we will test stocks that are currently in S&P 500 index. Here are some selected results (using NinjaTrader software using data from Kinetick):
|Number of trades||474|
|Average time in market||277 days|
It is interesting to note that this simple strategy will really result in some profit. It can be even surprising that the percent of profitable trades is quite high (almost 68%). Of course, the main drawback is a high maximum drawdown (-15.16%). It is perhaps not as bad as using SMA-cross strategies, but still a bit too much.
Now, let us do the same for stocks from Russell 3000 index. The results are as follows:
|Number of trades||1430|
|Average time in market||272 days|
Theoretically, the strategy will lead to some income. Nevertheless, I remind that this strategy does not specify any stop-loss level and therefore it is generally not recommended as such (even though it performs relatively decent in backtesting).
Anyway, this strategy shows actually something else: it is a bit risky to short a stock/currency pair/commodity whose price has reached some oversold level. Similarly if we want to buy a stock that is overbought: perhaps better wait until the price drops (to e.g. some support level) and then buy the stock.