Pros & Cons
|– Some time periods are highly effective||– Certain Periods do not work well on other time frames|
|– Catch long term swings||– Can tie up positions for longer term|
|– Easy to find long//short indications||– Losing trades must adjust to changing RSI|
The RSI strategy is mainly focused on patterns and reversions based on overbought or oversold conditions marked by the indicator. It’s designed to take less trades, but it is a powerful tool in measuring market conditions and, most of the time, is accurate if traded correctly. What you may notice further into the guide, is that these set ups are meant for long term swings on small lot sizes at first to scale in to individual positions without overrisking (that’s not a word) your account. The 14-Day RSI, or Relative Strength Index, measures the overall ‘strength’ of the market by taking the average of the last 14 days’ closing price. By definition, RSI shows you the relative strength or weakness in a market.
Very similar to the XMR Strategy, which uses the averages of multiple RSI’s, however this strategy only uses one time period of 14 days.
As you can see from the chart above, the trade set ups are meant to look like this. When RSI crosses above or below a certain level, trade set ups are made clear on the chart looking at EUR/USD.
Immediate Concerns & Disclaimer
Because this strategy is not designed to incorporate a strict stop loss like other strategies, I do not suggest it for everyone. If you are someone who does not feel comfortable without a stop loss on your trades, I would suggest trying another concept than this one. That being said, trading with a stop loss is not the only way to manage risk, in my view.
We will cover some of the built in alternatives used in this strategy later on. Of course, any exposure to the market can result in significant loss, and trading is not for everyone. This strategy involves mostly strict rules, with a touch of discretion involved. That being said, let’s continue!
Overbought vs Oversold
Technically, any RSI reading of 30 or under means that the price is oversold and any reading at or above 70 is overbought. It’s hard to say when price will turn back around in the other direction, but entering a trade once RSI crosses over 70 or below 30 does not always guarantee that price will follow.
Here is an example of getting tied up in a trade after RSI reads oversold. As you can see, new trades weren’t made until RSI charted a lower number than before. This trade would have ended profitable if the trader closed out of the trade once RSI hit 50 assuming all lot sizes were the same. The trader would have also been stuck in the trade for weeks before they closed out, but this happens in trading as no strategy is pitch perfect. That is why it is important to adjust entries as well as knowing when to get in.
Entries & Exits
Figuring out a good entry is not ever easy, so it’s best to come up with a plan before you enter a trade. One method that I could use is by starting small (lot sizes). Let’s say I was in this EUR/USD trade for a swing, as in maybe a month. If I recognized that my money could be tied up for a while, I would start with small lot sizes relative to your account. Another approach to taking this trade could be to buy once RSI crosses below 30 and closing at the most recent upswing.
This is more of a short term rinse-and-repeat strategy where you can take quick trades (1-2 days) just by trading off the RSI levels. I like to trade this way as well because deciding that your money will not be in the trade for long, whether the price swings in either direction, you know that you will close before you are forced to hold positions in drawdown.
However, in extreme conditions of being overbought/oversold, you can catch great moves like this on USD/CAD. An entry on oversold conditions (<30 RSI) and a close at overbought conditions (>70 RSI) resulted in a great swing in profits. Something important to realize regarding this strategy is that not every entry is going to be exactly the same. In cases like the COVID crash in March, some pairs went well oversold and continued to push down passed those levels. In times of big market swings, no strategy will work as planned, and picking the momentum becomes more important than entering at extreme levels.
When the market moves this hard in one direction, buying at the first signs of overbought would end up being a significant loss, although you would have been profitable in your account. This strategy should never put you in a position of negative equity for the risk of being margin called. This was a very rare circumstance, but it must be addressed because situations like this are clearly possible. The previous example was based on ‘normal market conditions’ where there was not an immediate threat to global economies all at once. So, once you start seeing huge swings on the daily candle, it’s probably not a good time to gauge an entry until the volatility has cooled down.
Risk Management and Adjusting Trades
That leads me into how to mange your risk when trading this strategy. Just to be clear, by no means is this a strategy that I created; I do not coin this as my own. In fact, it’s a very common strategy that many traders like to use, but I have concocted some ideas that are different from regular RSI traders.
Because we’re trying to make long term swings (several days, weeks, months, etc.), I like to start really really small in lot size. We’re talking a .01 lot to start off with and gradually reaching a .05 lot if needed. Accumulating small positions may sound unattractive to the trader that wants a get-rich-quick scheme, but let me tell you: with greater reward comes greater risk. Starting with big lots can absolutely destroy any size account. Believe me on this because I have made lots of mistakes in my past, so I’m letting you know before you learn the hard way like I did.
Let me show you an example on how I would use my drawdown to my advantage.
This is what I mean when I say you have to be prepared for adjusting your entries. When RSI turned to create a new low, a buy position was entered with a larger lot size. Sticking to the strategy may require a lot of patients sometimes, and you may have to deal with some drawdown, but that is the purpose of starting with small lot sizes.
For the traders that like to search for reversal trading, the RSI strategy is a great tool for looking at when it’s time to long or short and how to adjust to the trade if things don’t work out in the beginning. In a way, this strategy is best when adjusting trades. No one wants to miss a reversal move, so getting in on the first sign can only work out if you recognize that you could be in drawdown and another buy/sell position may have to happen. Overall, the strategy works well if traded the way I’ve mentioned above. If you’re not an RSI trader, I still think using this tool is great for analyzing markets for any strategy you wish to use.