Trading strategy: RSI 2P

Description

The 2-period Relative Strength Indicator (RSI) strategy was developed by Larry Connors. RSI 2P is based on the principle that market prices return to a mean after significant highs or lows. The strategy, however, does not attempt to identify major tops or bottoms. It tries to identify overbought situations (short sell opportunities) in a negative market and oversold situations (buy opportunities) in a positive market.


  
Suitable for : Market indices (DAX, CAC, DOW...)
: Forex (EUR/USD ...)
: Commodities (Oil, Gold, ...)
: Stocks
Instruments : Futures, CFDs, Forex
Trading type : Day trading
Trading tempo : Low, 1-2 signals per day in 60’
Using NanoTrader Full : Manual and semi-automated

 

The strategy in detail

When the market is in a positive trend the strategy looks for oversold situations (buy opportunities). When the market is in a negative trend it looks for overbought situations (short sell opportunities). In order to determine if the market is in a positive or a negative trend a 200-period moving average (MA) is used. If the market price is above the 200-period MA, the trend is positive. If the market price is below the 200-period MA, the trend is negative.

In order to identify overbought or oversold situations Connors uses the 2-period RSI. In short, the signals are generated by the 2-period RSI and filtered by the 200-period MA. For day trading purposes, the strategy can be applied in a 30 or 60-minute time frame.

When to open a position?

A buy signal is generated when
- the 2-period RSI goes below 5 and
- the market price is above the 200-period MA.

A short sell signal is generated when
- the 2-period RSI goes above 95 and
- the market price is below the 200-period MA.

The position is opened at the open price of the next candle after the signal.

When to close a position?

Connors closes positions on the basis of the 5-period MA. A long position is closed when the market price closes above the 5-period MA. A short position is closed when the market price closes below the 5-period MA. This is a closing strategy that will produce quick exits.

Connors does not use stops on open positions! In the platform, however, a percentage stop (3% price change versus the entry price) has been added. The 3% stop is used and suggested by the Italian trader Gabriele Bellelli. This gives users the option. If, like Connors, you do not wish to have a stop you can either temporarily replace the 3% with a very high % or you can delete the stop altogether in the designer dialog.

 

This example shows two buy opportunities. The market is in a positive trend because the market price is above the 200-period MA (blue curve). In a positive trend the strategy looks for buy opportunities when the market is oversold. The market is oversold when the RSI drops below 5. In both trades the long position is then sold when the market closes above the 5-period MA (purple curve).


 

This example shows two short sell opportunities. The market is in a negative trend because the market price is below the 200-period MA. In a negative trend the strategy looks for short sell opportunities when the market is overbought. The market is overbought when the RSI goes above 95. In both trades the short position is then bought back when the market closes below the 5-period MA (purple line). The orange horizontal line is the 3% safety stop.


 

This example illustrates the use of having the 3% safety stop. Connors, who developed the RSI 2P strategy, does not work with a stop.

 

Conclusion

The 2-period RSI strategy is based on the concept of a return to the mean price. In case the market is oversold or overbought the strategy expects the market price to return to the mean market price. The strategy opens short positions in a downtrend when the market is overbought. The strategy opens long positions in an uptrend when the market is oversold. It is a simple strategy which can be applied to all financial instruments for day trading. Connors also uses the strategy for swing trading (positions open for days). In this case he opens the positions earlier; somewhat before the market close instead of at the next day open.

Practical implementation

In NanoTrader Full follow these steps:
  • Choose the instrument you wish to trade.

  • Open a chart with the template study "WHS RSI 2P".

  • Semi-automated trading? Simply activate the TradeGuard+AutoOrder or the AutoOrder function.