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Rules for Day Trading with the RSI

Rules for Day Trading with the RSI

Here are some rules for using the RSI and its first derivative for day trading.

1. Using RSI as an overbought or oversold timing indicator is very simВэple. Select your cutoff points (as you do with stochastics). If, for examВэple, you select 25 and 75, then your procedures would be as follows:

a. When RSI drops to 25 or lower and then turns back above 25 you buy and use a stop loss either under the lowest most recent low or a risk management stop loss.

b. When RSI has been at 75 or higher then sell short when it declines below 75 using a stop loss above the most recent high or use a dolВэlar risk management stop loss.

For procedures a and b you can vary the values. Figure 8-7 shows the use of a 9-period RSI on 30-minute S&P data with 15 and 85 as the cutoff points. Note my buy and sell points on the chart. As you can see, RSI is a valuable tool for the day trader. Note that RSI turned bullish on 12/9 and remained so through 12/19. This gave the day trader an opportunity to buy every day so long as the bias was bullish because of the bullish RSI.

2. Using the first derivative of RSI (or other derivatives if you wish) is like using an oscillator. The procedure is simple:

a. When RSI falls below its first derivative, sell short and either use a stop loss as the reversal signal (i.e., RSI closing above its derivaВэtive) or use a dollar risk stop loss.

b. When RSI goes above its first derivative, then buy with a stop loss either as a signal reversal or as a dollar risk stop.

In all cases you must remember that a signal is not activated until the time segment has ended. In other words, if you are using a 5-minute chart, RSI will change every time the market has changed price; it is only the RSI value at the end of the 5-minute segment that's considered for timing sigВэnal purposes.

A Suggestion

Before leaving the RSI, I'll share with you an idea which I've just started to research which I feel has incredible potential. If you use a 14-period slow stochastic as your first derivative of RSI, you'll find that your sigВэnals will be even more accurate. What do I mean? I mean that instead of calculating the stochastic on price, you will calculate a stochastic of RSI. This can be easily done on the CQG (Commodity Quote Graphics) sysВэtem as well as on others. Examine Figure 8-8 along with my comments on the chart. I feel strongly that this approach has outstanding potential for day trading and that it should be pursued aggressively. There are many other possibilities. Consider using an RSI of the RSI as a derivaВэtive, or for that matter another indicator applied to the RSI that will act as a smoothing factor. The idea here is, of course, to reduce the number of false or losing signals by making RSI less sensitive but at the same time not delaying its response to changing market conditions.