Combining RSI Range and RSI Momentum for Stocks

Some traders use a Relative Strength Index (RSI) range to identify trend and RSI extremes to signal turning points. How long should they require that RSI remain in range, and how often should they require that RSI recapture a momentum threshold? In his December 2018 paper entitled “Finding Consistent Trends with Strong Momentum – RSI for Trend-Following and Momentum Strategies”, Arthur Hill systematically tests the predictive power of 14-day RSI range and momentum signals on S&P 500 stocks. Specifically, he tests each of the following five signals over lookback intervals of 25, 50, 75, 100 and 125 trading days:

1. RSI Bull Range: RSI between 40 and 100.
2. RSI Bear Range: RSI between 0 and 60.
3. RSI Bull Momentum: highest high value of RSI greater than 70.
4. RSI Bear Momentum: lowest low value of RSI less than 30.
5. RSI Bull Range-Momentum: combination of 1 and 3.

For example, 25-day RSI Bull Range signals buy at the close when 14-day RSI has been between 40 and 100 over the last 25 trading days and sell at the open when it next crosses below 40. His performance metrics are gross Success Rate (frequency of positive/negative returns after buy/sell signals) and gross Profit/Loss Ratio (average gain of successful trades divided by average loss of failed trades). Using daily prices for historical S&P 500 stocks during July 1998 through June 2018, he finds that:

• Over the full sample period, average 14-day RSI is 57.6. RSI is above 70 (below 30) about 6% (3.5%) of the time.
• Across lookback intervals:
  1. RSI Bull Range signals have Success Rates 34% to 37% and Profit/Loss Ratios 2.35 to 2.52, with 25-day (100-day) lookback optimal for the former (latter).
  2. RSI Bear Range signals have Success Rates 25% to 28% and Profit/Loss Ratios 1.28 to 2.11, with 100-day (25-day) lookback optimal for the former (latter).
  3. RSI Bull Momentum signals have Success Rates 52% to 58% and Profit/Loss Ratios 1.37 to 2.11, with 125-day lookback optimal for both.
  4. RSI Bear Momentum signals have Success Rates 31% to 39% and Profit/Loss Ratios 1.02 to 1.12, with 25-day lookback optimal for both.
  5. RSI Bull Range-Momentum signals have Success Rates 45% to 58% and Profit/Loss Ratios 1.84 to 2.40.

In summary, evidence suggests that stock traders may be able to boost performance by combining RSI Bull Range and RSI Bull Momentum indicators with lookback intervals of 75 to 125 trading days.

Cautions regarding findings include:

• As noted in the paper, performance statistics are gross, not net. Accounting for trading frictions would lower Success Rates and Profit/Loss Ratios.
• Testing many signals/parameter settings on the same sample impounds data snooping bias, such that the best results overstate expectations. The more alternatives, the greater the bias. There may also be snooping bias inherited from prior studies via the selected fixed RSI threshold settings.
• The study does not address consistency of signal performance across subperiods.
• All testing is at the trade level. Portfolio-level analyses may contradict attractiveness of trade-level findings. Signals may cluster in time across stocks, such that there are sometimes many stocks to trade and sometimes few or none. Addressing this variation generally involves cash reserves and missed opportunities, such that portfolio-level performance is worse than trade-level performance.
• The study considers only large-capitalization stocks. Findings may not apply to small stocks, assets from other classes or aggregations of stocks such as exchange-traded funds.