2 Period RSI Reloaded - Excellent Trading Strategy Combining With Fast Stochastics

We consider the Relative Strength Index (RSI) to be one of the best indicators available. There are a number of books and articles written about RSI, how to use it, and the value it provides in predicting the short-term direction of stock prices. Unfortunately, few, if any, of these claims are backed up by statistical studies. This is very surprising considering how popular RSI is as an indicator and how many traders rely upon it.

Most traders use the 14-period RSI, but enhanced studies have shown that statistically, there is no edge going out that far. However, when you shorten the timeframe you start seeing some very impressive results. Some good research by Larry Connors shows that the most robust and consistent results are obtained by using a 2-period RSI and I have built many successful trading systems that incorporate the 2-period RSI. The following is one of them.

What is RSI? The Relative Strength Index (RSI) was developed by J. Welles Wilder in the 1970's. It is a very useful and popular momentum oscillator that compares the magnitude of a stock's recent gains to the magnitude of its recent losses.

As mentioned above, the default/most common setting for RSI is 14-periods. You can change this default setting in most charting packages very easily but if you are unsure how to do this please contact your software vendor. Those using Amibroker can easily change the period of RSI.

Trading System Prerequisites:
Any good charting software like Amibroker (recommended), Metastock, Trade Station, Advanced Get etc. Those do not have any of them can contact us at 9432883838/9674321856 or mail at stockmaniacs@ymail.com to buy Amibroker.

Trading System Setup:

Time frame: Daily/Hourly/30 Minutes/15 Minutes

Scrip: any liquid scrip or index

Trading setup: SMA 50, SMA 100, SMA 200, RSI (2) with horizontal lines at 80 and 20, Fast Stochastics (6, 3, 3) with horizontal lines at 70 and 30.

Trading rules:

Entry for uptrend: When the 50 SMA is above 100 SMA and 100 SMA is above 200 SMA, it is buy only setup. We will look for RSI to plunge below 20. Then look at Stochastic - once the Stochastic lines crossover occur and it is (must be) below 30 - enter long with a new price bar. If at least one of the conditions is not met - stay out.

Opposite for downtrend: When the the 50 SMA is below 100 SMA and 100 SMA is below 200 SMA, it is sell only setup. Wait for the RSI to go above 80. Then if shortly after you see a Stochastic lines crossover above 70 - enter Short.

Protective stop is placed at the moment of entry and is adjusted to the most recent swing high/low. I have shown the system with Nifty future daily charts.

Profits are going to be taken in the following way:

• Option 1 - using Stochastic - with the Stochastic lines cross above 70 (for uptrend) / below 30 (for downtrend).
• Option 2 - using a trailing stop - for an uptrend a trailing stop is activated for the first time when Stochastic reaches 70. A trailing stop is placed below the previous bar's lowest price and is moved with each new price bar.

This strategy allows to accurately pin-point good entries with sound money management - risks/protective stops are very tight and potential profits are high.

Current trading strategy can be improved when it is combined with the best exits. For example, once in trade the traders may also try applying Fibonacci studying to the most recent swings. This way they can predict short-term retracements and make sure they will not be pulled out of the trade early and will continue pursuing profit targets at Fibonacci extension levels. (Some idea of the system is taken from a forex discussion forum, big credit goes to Edward Revy)