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Back-tested Results on Long-RSI Strategy
[/vc_column_text][vc_separator css=”.vc_custom_1647104434529{margin-bottom: 30px !important;}”][vc_column_text](For those who don’t want to read till the end: RSI oversold zone of 44 and a trailing stoploss of 5% generated a CAGR of 19% over the last 21 years on NIFTY 50)
It doesn’t take retail traders very long to realise that discretionary trading isn’t going to take them very far, both in terms of financial capital and mental capital. And thus, they venture on to discover their preferred method of trading (their ‘aha’ moment), constantly working to bring about some system in their trading, hence the term ‘systemic trading’.
Successful trading is not only about making profits, but making profits using methods that you know you can replicate to reap similar results. And while understanding price action isn’t everybody’s cup of tea, people gravitate towards using indicators. But a majority of the traders’ community believes it all to be farce. An inherent belief is that indicators such as RSI, MACD, Stochastics etc. just don’t work, and that they are ‘lagging indicators’
Well, the trick to using them profitably is… come closer… DISCIPLINE. And so, we have done the heavy lifting for you, all that is left for you is to read on, understand our logic, assess our results, and simply start inculcating the methods in your process too. And as history is our witness, you shall reap profitable results.
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What is Relative Strength Index (RSI)
The relative strength index (RSI) is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset. The RSI is displayed as an oscillator (a line graph that moves between two extremes) and can have a reading from 0 to 100. The indicator was originally developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, “New Concepts in Technical Trading Systems.”
Traditional interpretation and usage of the RSI are that values of 70 or above indicate that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective pullback in price. An RSI reading of 30 or below indicates an oversold or undervalued condition.
The internet will do a better job than this article of explaining how the RSI is calculated. So, I will not attempt to bore you with those details. What you are going to learn in the rest of the article is how you can successfully use this indicator called RSI, a back-tested trading strategy and I will try my best to instill confidence in this method by transparently displaying the statistics.[/vc_column_text][vc_single_image image=”68465″ img_size=”medium” alignment=”center” css=”.vc_custom_1647105938893{margin-top: 20px !important;margin-right: 20px !important;margin-bottom: 20px !important;margin-left: 20px !important;}”][vc_column_text css=”.vc_custom_1647104516216{margin-top: 20px !important;margin-bottom: 10px !important;}”]
Back-testing Process
(For the sake of simplicity, we have ignored transaction costs and rollover costs and assumed that NIFTY is tradeable like equity without the need for it to be bought in futures, since now we have many ETFs to trade the same)
We took more than 21 years of NIFTY 50 data from the NSE’s website – from Jan 01 2000 up till Mar 11 2022 to test our thesis.
Further, we calculated RSI for all the days based on closing data.
Our data sheet appeared like this:
[/vc_column_text][vc_single_image image=”68467″ img_size=”large” alignment=”center” css=”.vc_custom_1647104754925{margin-top: 10px !important;margin-bottom: 20px !important;border-top-width: 1px !important;border-right-width: 1px !important;border-bottom-width: 1px !important;border-left-width: 1px !important;border-left-color: #000000 !important;border-left-style: solid !important;border-right-color: #000000 !important;border-right-style: solid !important;border-top-color: #000000 !important;border-top-style: solid !important;border-bottom-color: #000000 !important;border-bottom-style: solid !important;border-radius: 1px !important;}”][vc_column_text css=”.vc_custom_1647104893540{margin-bottom: 10px !important;}”]Now we enter a long trade i.e we BUY Nifty 50 index when RSI comes above a certain value from below. Now traditionally, this value was decided to be 30, called the oversold line. A BUY signal was generated when the RSI showed a reading of more than 30 after staying down below it for an indefinite amount of time.
We HOLD the trade for as long as our stoploss/trailing stoploss is triggered. When either one of them we are triggered, we close the trade and book the profit/loss and then wait for RSI to present a BUY signal again and the whole process is repeated.
See the red arrows in the image below to check under what circumstance would our logic present a BUY signal for an RSI oversold zone of 40:
[/vc_column_text][vc_single_image image=”68468″ img_size=”full” alignment=”center” css=”.vc_custom_1647105008066{margin-top: 10px !important;margin-bottom: 20px !important;border-top-width: 1px !important;border-right-width: 1px !important;border-bottom-width: 1px !important;border-left-width: 1px !important;border-left-color: #000000 !important;border-left-style: solid !important;border-right-color: #000000 !important;border-right-style: solid !important;border-top-color: #000000 !important;border-top-style: solid !important;border-bottom-color: #000000 !important;border-bottom-style: solid !important;border-radius: 1px !important;}”][vc_column_text css=”.vc_custom_1647107160963{margin-top: 10px !important;}”]The trading thesis that we are trying to prove here is if you follow the method with utmost discipline, you will have an uptrending equity curve. As you may have heard the phrase, ‘the devil is in the details’, it is vital what we choose our oversold region criteria and stoploss points to be. Let’s dive into it.
Back-testing Results
We have two variables in our analysis: RSI Oversold Zone and the Stoploss Criteria. For example, our rule can be that we will buy NIFTY when RSI goes above 40 from below and we put an initial stoploss of 4% and then simply trail our stoploss by 4% on the closing price if the trade starts to move in our favour. Our stoploss is triggered when NIFTY goes below our stoploss and we book the profits/loss.
Now, we played around with these variables to find the best pair. Below is a sensitivity analysis of what would the end capital be on 11th March 2022 if we started using the stated logic from 1st Jan 2000 and our initial capital was 100000.
Please note that the figures below are in Rs. Lakhs and stoploss can be calculated as (100% – SL%).
[/vc_column_text][vc_single_image image=”68469″ img_size=”full” alignment=”center” css=”.vc_custom_1647105323812{margin-top: 10px !important;margin-bottom: 20px !important;border-top-width: 1px !important;border-right-width: 1px !important;border-bottom-width: 1px !important;border-left-width: 1px !important;padding-bottom: 1px !important;border-left-color: #000000 !important;border-left-style: solid !important;border-right-color: #000000 !important;border-right-style: solid !important;border-top-color: #000000 !important;border-top-style: solid !important;border-bottom-color: #000000 !important;border-bottom-style: solid !important;border-radius: 1px !important;}”][vc_column_text css=”.vc_custom_1647107247677{margin-bottom: 10px !important;}”]Taking a case from the table above, if we take our RSI oversold zone to be 40 and we put a stop of 4% (96% of price) then Rs. 1 lakh would become Rs. 10.2 lakh in 21 years, giving a compounded annual growth rate of 12%.
Similarly, if take our RSI oversold zone to be 50 and we put a stoploss of 3% (97% of price), then Rs. 1 Lakh would become Rs 13 lakh in 21 years
Another example, if we assume our oversold RSI Zone to be 57 and we keep a stoploss of 14% (86% of price), then Rs. 1 lakh would become Rs. 7.2 lakh in 21 years.
We can’t help but notice the greenest point in the table, which brings me to the meat of the matter. If we put our RSI oversold zone to be 44 and we keep a stoploss/trailing stoploss to be 5% (or 95% of the closing price at that point), our Rs. 1 Lakh would have turned to a whopping Rs 42 lakh in 21 years. It amounts to a compounded annual growth rate of 19%!
Congratulations, you just beat majority of mutual fund returns, just by looking at RSI and the closing price of NIFTY 50. Here is the equity graph and and stats on this strategy over the years.
[/vc_column_text][vc_single_image image=”68470″ img_size=”full” alignment=”center” css=”.vc_custom_1647105917985{margin-top: 10px !important;margin-bottom: 20px !important;}”][vc_single_image image=”68471″ img_size=”full” alignment=”center” css=”.vc_custom_1647105837826{margin-top: 10px !important;margin-bottom: 20px !important;border-top-width: 1px !important;border-right-width: 1px !important;border-bottom-width: 1px !important;border-left-width: 1px !important;border-left-color: #000000 !important;border-left-style: solid !important;border-right-color: #000000 !important;border-right-style: solid !important;border-top-color: #000000 !important;border-top-style: solid !important;border-bottom-color: #000000 !important;border-bottom-style: solid !important;border-radius: 1px !important;}”][vc_column_text]We have not considered taking an RSI reading below 35 since that produced less number of signals, meaning RSI went below 30-35 a lot less frequently. It is vital to select the right pair of assumptions for RSI and stoploss to strike the right balance between the number of trade signals and correct holding period to ride the trend.
Bottomline
Please, don’t get us wrong, we do not intend to present the idea that RSI oversold zone of 44 and a stoploss of 5% is closest you will ever come to finding the holy grail. No sir. In fact, I would urge you to look at the sensitivity analysis once again. In none of the settings would you see negative returns; our capital has only grown with time, slowly for some settings and quite fast for some others.
This brings me to my final and most important point; there is no ‘one size fits all’ scenario in the stock markets. Maybe RSI-44 and stoploss-5% may not be the best assumptions for NIFTY going forward; maybe they won’t be the best setting for some other scrip. These numbers are more arbitrary than logical and it the strength of discipline and confidence in your system that actually brings you the profit.
The system presented above worked so well because of two reasons; first, we rode the trend for as long as our stoploss wasn’t triggered; second, because we respected our stoploss every single time and didn’t let out emotions meddle with our process. This way, our losses were small and capped, but our profits were huge and uncapped.
Now, it is statistically proven that following an indicator can reap positive returns, even on a long enough time frame. You just have to couple the use of an indicator with unfaltering discipline.
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