The STC RSI Stock Trading System By Chuck LeBeau
Our Bulletin number 48 about using RSI sparked some very interesting discussion on our FORUM. One of the messages suggested that buying stocks when the RSI was below 25 and then selling them when the RSI went above 45 produced some excellent historical results, particularly in the Dow stocks.
I thought I would check it out and ran some historical tests. Lo and behold it worked remarkably well. I immediately observed that there was the makings of a viable system here. All it needed was a little refinement.
After a few days on tinkering I came up with a version of the system that I think is worth trading. Since our members on the FORUM originated the basic system, I thought I would also pass along my work on this system so that all of our members might benefit.
Here are the stock trading rules I came up with:
ENTRY: When the 14-day RSI is 25 or less, enter an order to buy tomorrow on a stop at today's close plus some small amount. Use a couple of cents or .02 units of Average True Range above the previous close. We need to avoid buying on weakness because it's a bit like trying to catch a falling safe. When the RSI is at a low level the stock is likely to be gapping lower and falling apart to the downside and we don't want to buy that much weakness. So to avoid buying on further weakness we require that we must buy only on a price above today's close. That requirement keeps us out of a lot of trouble.
PROFIT TAKING: Take profits when the 14-day RSI recovers and closes at any level above 45. Just sell the next day on the open. Closing out the trade at such a low level on the RSI seems counter-intuitive but it works. What tends to happen is that the RSI can often recover quickly and gap well above 45 so that we are often taking the profits at levels much greater than 45. I tried a lot of other levels trying to increase the profits on the winners but selling above 45 makes the most money.
LOSS PROTECTION: After the trade has been open for four days or more exit on any day that the RSI closes lower than yesterday. Just sell the next day on the open. This is our equivalent of loss protection. If we have been in a trade for four days or more and the RSI has not recovered to 45 we don't want to hold it while the RSI declines again.
I tested the simple system described above on a portfolio of 28 stocks from 1987 through October 2001. In this more or less random portfolio there were some Dow stocks plus a few stocks with more volatility. The results were generally acceptable but there were some particular results that I thought were truly amazing.
First the typical performance results from buying $10,000 worth of stock on each signal with no compounding:
Total net profit: $255,557 Number of trades: 1849 Winning trades: 1124 (60%) Losing trades: 725 (40%) Average winning trade: $489 Average losing trade: $406 (Ratio avg. win/avg. loss 1.21) Maximum consecutive winners: 18 Maximum consecutive losers: 8 Average bars in winners: 3.5 Average bars in losers: 4.4 Largest intraday drawdown: $28,820 (This occurred in October 1987) Profit factor (Gross profits divided by gross losses) 1.87 Sharp ratio: 1.12
Now these results are pretty good overall but what really got my attention was a couple of additional calculations that are provided in my BEHOLD software. We like to look at the number of rolling 2month windows and see how many 12-month periods were possible. (After the first eleven months each new month provides a new12-month period to be examined.) There were 161 of those 12-month windows in our test and every one of them was profitable. This system did not have a single 12- month period where it lost money. That is truly remarkable. Although the biggest intraday drawdown was in October 1987 (no surprise) the system actually finished that month with a big profit. This is a system that seems to be able to take advantage of market weakness.
Another measurement that got my attention was the percentage of bars in the market and the dollars returned per day in the market (based on buying $10,000 worth of stock). This system is not in the market very often; it had trades on only 7% of the bars. But it returned a profit of $35.64 for every bar in the market. To put this number in perspective, any return of $10 per day or more on a $10,000 investment is considered very good.
Now as always, there are a few warnings. When testing stocks that have been back adjusted for splits it is nearly impossible to factor in commissions with any accuracy so no commissions or slippage are included in these results. But we are trading stocks now for a penny a share or less and commissions should not have a big impact because the system trades very infrequently. (About 4 trades per year per stock.) If we deduct a few thousand dollars from our results to cover costs the results are still very acceptable.
This system has no fixed dollar stop loss so the potential loss on any trade is unlimited. For this reason you would want to trade very small positions relative to your total capital (a good idea in any case). That way if you took a big hit on one trade it would represent a very small percentage of your capital. In our historical testing the largest losing trade was $3,239.
We think this RSI based system deserves further examination. We intend to incorporate a version of it on our StreakingStocks web site (www.StreakingStocks.com). We like the way it takes advantage of buying during periods of extreme market weakness. If we combine this system with a good trend-following system that can make money when the market is strong we should be able to make money on a very consistent basis.
Test the system yourself and see what you think. If you come up with any improvements please let us know.
Good luck and good trading.
* * * * * * * November Workshop -Limited spaces still available.
Learn How to Design, Test, Evaluate and Implement Profitable Trading Systems. Whatever your market and whatever your time frame you are certain to benefit from this carefully prepared two-day workshop. On November 10th and 11th Chuck LeBeau will personally teach a small group of traders the step by step process of how to design better trading systems.
It doesn't matter if you trade stocks or futures or if you are a day trader or a position trader. The procedures that need to be followed are the same and you will learn what you need to know to improve your systems at this informative Workshop.
Contact Chuck LeBeau at (310) 265- 9776 for more information or go to
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* * * * * * * * Visit our FORUM discussion group and share ideas with other traders.
The Traders Club Forum is the best discussion group for traders anywhere on the web. We have many lively and informative threads in progress that will increase your knowledge and generate helpful ideas. If you are new and need questions answered this is the place. You will find that our Club members are knowledgeable and very helpful. It's a very friendly and supportive group and you will be surprised at the amount of information and assistance that is available. The discussions are very high quality and best of all - IT'S ALL FREE.
Just go to http://www.traderclub.com/discus/board.html and take a look.
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