Trading strategy: Dynamic RSI
Description
The Dynamic RSI strategy is used for swing trading on market indices and shares. It is a strategy which gives relatively few signals. Traders who apply this strategy tend to work with a large range of indices and shares. The strategy was developed by a Dutch analyst.
Given the limited number of signals and the ensueing need for investors to work with a large range of instruments, it is advisable to use WHS TechScan. The WHS TechScan module (present in all WHS trading platforms) scans all shares and indices on a daily basis and, amongst others, identifies Dynamic RSI buy and sell signals.
| Suitable for | : Market indices (FTSE, CAC, DAX ...) : Forex (EUR/USD ...) : Shares |
| Instruments | : Futures, CFDs and Forex |
| Trading type | : Swing trading |
| Trading tempo | : Low - 1 signal per month |
| Using NanoTrader Full | : Manual or automated |
The strategy in detail
When to open a position?
The classic RSI, as developed by Welles Wilder, is an oscillator. An oscillator measures the speed and the strength of price movements. If a price movement is of sufficient strength and speed, the RSI will evolve above or below one of two crucial levels. These levels indicate the overbought and the oversold zones. When the market price has evolved in such a way that the RSI is in one of these zones, traders consider the probability high that a price movement in the opposite direction will start.
There are two issues with Welles Wilder’s classic RSI. Firstly, the indicator does not take into account the intrinsic volatility of a financial instrument. Secondly, the overbought and oversold levels are static (i.e. they have a fixed value) and are identical for each financial instrument. The Dynamic RSI solves these issues by introducing dynamic overbought and oversold levels. These dynamic levels adapt to the instrument and the market’s evolution.
This screenshot clearly shows the difference between the classic RSI with fixed overbought and oversold levels and the Dynamic RSI with variable overbought and oversold levels.
When the Dynamic RSI indicator line crosses the lower band an instrument is considered "oversold". In this case a price rise may occur. When the Dynamic RSI indicator crosses the upper band an instrument is considered "overbought". A price drop may occur. Positions are not opened immediately when the levels are crossed. Positions are only opened when the Dynamic RSI has crossed back into the middle zone.
This screenshot shows a total of five signals. Two short sell signals (1 and 4) and three buy signals (2,3 and 5). Positions are only opened when the Dynamic RSI indicator re-enters the middle zone. The circles indicate these entry points.
Attention. Some traders apply a trend filter to the Dynamic RSI signals. When the trend is positive (bullish) only buy signals are valid. When the trend is negative (bearish), only short sell signals are valid. In order to determine the trend they will often use a 3 Line Break chart and/or the SuperTrend indicator.
A 3 Line Break chart is a chart which only displays relevant price movements. Since it does not display all price movements its time axis is discontinuous. The 3 Line Break chart is a good trend indicator. In this screenshot the trend is currently positive. Only buy signals are valid.
The SuperTrend indicator developed by O. Seban is equally helpful to visualize the trend. When the stop line lies below the market price the trend is positive. When the stop line moves above the market price the trend is negative. In this screenshot the trend is currently positive. Only buy signals are valid.
When to close a position?
As is often the case with strategies developed by analysts the focus is on the entry. Only limited information is provided about the exit of a position. The trader can solve the exit issue himself. In this case target and stop can be determined on the basis of the daily ATR (average true range). For example a target of 2x ATR and a stop of 1x ATR would result in an acceptable return/risk of 2.
Conclusion
The Dynamic RSI strategy brings to live the classic RSI indicator developed by J. Welles Wilder. Due to the limited number of signals per instrument investors need to work with a large range of shares and market indices. A scanner, like WHS TechScan, makes work light.
Practical implementation
- In WHS TechScan:
Open WHS TechScan.
The section "Trading Strategies" contains all Dynamic RSI signals on shares.
In the left margin click "Indexes" or "Currencies" to get Dynamic RSI signals on these instruments.
- In NanoTrader Full follow these steps:
Choose the instrument you wish to trade.Open a chart with the study "WHS Dynamic RSI".
The strategy is set-up for position exits based on the Slow Stochastics.