FXstreet.com Live Sessions Archives: Using RSI in trading systems

Date: December 22nd, 2005 - 14:00GMT

Expert: Igor Belitsky, Analyst of FX-Dealer.com

Topics:

General RSI trading rules
Composition of RSI and Bollinger Bands
Trading System example

Who Igor Belitsky?
Igor Belitskyis a specialist in applied mathematics and trading systems development. Since 1996 he has been working as a forex market analyst in a Moscow based financial company

Speech Material:

Using RSI in trading systems

1. General RSI trading rules
Relative Strength Index (RSI) is the most popular technical indicator. Below are 4 well-known RSI trading rules:

RSI levels of 70% and 30% (80% and 20%) are known as overbought/oversold levels. Buy signal generated when the market is oversold, sell signal generated when the market is overbought. These levels are only working good inside range phase and produce losses during trend phase.

EMA often plays the role of support and resistance just the same as for the price itself. Buy signal generated when RSI rises above its EMA, sell signal generated when RSI drops below it's EMA. EMA is always lagged behind and often produce buy signal when up-trend is over.

Bullish divergence and buy signal occurs when price makes a new low which is not confirmed by RSI, bearish divergence and sell signal generated when price makes a new high while RSI fails to make a new high. The main drawback of divergences is that they are trying to predict trend reversals instead of trend-following signals.

Chart formations like trends, support/resistance, triangles, head and shoulders and so on are applied to RSI just the same way as they are applied for the price. Bad thing is that chart formations like trends and triangles are very subjective and could not be used in trading systems.

2. Composition of RSI and Bollinger Bands
We apply Bollinger Bands study to RSI indicator. Buy signal is triggered when RSI falls below Lower Bollinger Band. Sell signal is generated when RSI rises above Upper Bollinger Band. There are many signals against the trend so we need to use some trend filter. We add MACD indicator as trend filter. If MACD>0 the trend is upward, if MACD<0 the trend is down.

The main advantage of using RSI with Bollinger Bands is that it helps to catch trading signals inside trend phase while standard overbought/oversold levels are useless inside trend. We believe that RSI(Bollinger Bands) composition study is working good both in range and trend phase while 80% & 20% RSI levels are only suited for ranges.

3. Trading System example
Below is USD/CHF 240 minute chart with sample automatic trading system. Sell signal is generated every time RSI rises above Upper Bollinger Band while MACD<0. Buy signal is generated when RSI falls below Lowe Bollinger Band while MACD>0.

Click to enlarge :

Click to enlarge:

If we used RSI overbought/oversold levels on the chart above we would have missed sell signals inside down-trend as well as buy signals inside up-trend phase while composition of BOB(RSI) works fine.

Below is equity chart for this trading system based on target order = +400 pips and stop-loss order = -200 pips. There are 222 trades with total profit of 6040 pips. Spread of 5 points was included. We tested it on historical USD/CHF 240 minute chart with 2500 bars. This system is not perfect because maximum drawdown is more then 1500 points.

Click to enlarge:

Session Transcript:

FXstreet Moderador (Dec 22, 2005 10:01:40 AM)
Today I am delighted to welcome back our good friend and guest speaker Igor Belitsky, Currency Analyst of Fx Currency dealer.com

FXstreet Moderador (Dec 22, 2005 10:01:48 AM)
Igor is a specialist in applied mathematics and trading systems development. Since 1996 he has been working as a forex market analyst in a Moscow based financial company.

FXstreet Moderador (Dec 22, 2005 10:01:58 AM)
Be welcome Igor

Igor Belitsky (Dec 22, 2005 10:02:44 AM)
Hello dear friends. I am glad to talk with you again about trading systems development.

FXstreet Moderador (Dec 22, 2005 10:04:10 AM)
thanks Igor

FXstreet Moderador (Dec 22, 2005 10:04:21 AM)
Lets begin with pre Reg questions.

Igor Belitsky (Dec 22, 2005 10:05:05 AM)
1. Hi, i am using trendlines on RSI as sup-res and moving averages of RSI.What do you think about those tehniques as MA[RSI] often looks exactly as regular moving averages of price so it is laging but brake of RSI suport or resistance is better for entry than brake of price sup-res ?

Igor Belitsky (Dec 22, 2005 10:05:23 AM)
I also use trend-lines and supp&resist with simple RSI period=22. RSI breaks often happen just before actual price breaks.

Igor Belitsky (Dec 22, 2005 10:05:47 AM)
2. Why does RSI lot of the times when its oversold and overbought area change trend direction and other times the price goes into overbought and oversold direction even more? alexmatsuk

Igor Belitsky (Dec 22, 2005 10:06:05 AM)
I think that RSI in oversold/overbought area do not change trend direction. It's better to use RSI in trend direction to define exact entry levels.

Igor Belitsky (Dec 22, 2005 10:06:21 AM)
3. Did you try to programm and back-test your strategies? amsaar

Igor Belitsky (Dec 22, 2005 10:06:42 AM)
Yes we did. But there are no perfect strategies without series of losses because the market is often playing against all known strategies.

Igor Belitsky (Dec 22, 2005 10:06:57 AM)
4. What settings do you use for RSI and do you use simple or exponential moving averages? itzme

Igor Belitsky (Dec 22, 2005 10:07:11 AM)
For today's BOB(RSI) system we use RSI(7, simple, Close), BOB(10,1)

Igor Belitsky (Dec 22, 2005 10:07:31 AM)
5. Could you tell us the most profitable system in the world ? :) lickout

Igor Belitsky (Dec 22, 2005 10:08:09 AM)
I cannot tell you about our live armed trading systems. I just going to give you some ideas and basic principles of building good trading systems and direct you on this way.

Igor Belitsky (Dec 22, 2005 10:08:31 AM)
6. what time frames do you use? also, what times/sessions do you like? thank you btloms316

Igor Belitsky (Dec 22, 2005 10:08:45 AM)
We use 60+4H+Daily scales. We are trading during European and US sessions.

Igor Belitsky (Dec 22, 2005 10:09:02 AM)
7. I saw RSI at over 80% (overbought) and then I do to SELL but price goes up, over and over again. What happened? How to time periode to use it, what did 7 or 14 or others? How to chart to use it , 5 menit or 15 menit or others? How to combine with other indicator such Moving Average (with time periode? 7 or 20) ? septiana_marketing

Igor Belitsky (Dec 22, 2005 10:09:15 AM)
If RSI is over 80% the market is likely to go down only inside Range or Down-trend phase. During the Up-trend overbought levels do not work. For example, you can use RSI(7) when using our today's system, and RSI(14) or RSI(22) when drawing trend-lines on it.

Igor Belitsky (Dec 22, 2005 10:09:41 AM)
8. Hello.. Igor.. Where I put stop loss when I use RSI ? What your opinion about stop hunt? How to know these reversal or continues trend? gehosolo

Igor Belitsky (Dec 22, 2005 10:10:43 AM)
There are no ideal recommendation regarding stop-loss size. Generally if your signals come from 60 minutes chart you can use 30-50 pips stop, 240 min: 60-90 pips stop, Daily: 90-150 pips stop. Of course, you should also use standard money management rules like risk/reward ratio and risk/deposit ration for every single trade.

Igor Belitsky (Dec 22, 2005 10:11:29 AM)
Stop hunting is natural although most painful part of the market. There are no markets without it.

FXstreet Moderador (Dec 22, 2005 10:14:50 AM)
thanks Igor

FXstreet Moderador (Dec 22, 2005 10:14:58 AM)
let's start now tith live questions

FXstreet Moderador (Dec 22, 2005 10:15:05 AM)
Please post your questions now and Igor will attempt to answer as many as possible

JSB (Dec 22, 2005 10:15:54 AM)
What do u mean by "the RSI EMA?"

Igor Belitsky (Dec 22, 2005 10:16:14 AM)
Adding EMA on RSI

JSB (Dec 22, 2005 10:17:21 AM)
What charting package allow for BB overlay on RSI?

Igor Belitsky (Dec 22, 2005 10:18:09 AM)
FXDealerCharts do that. I think all technical analysis software should allow composition of any unlimited studies on one another.

gamegirl (Dec 22, 2005 10:18:37 AM)
Thanks for being here and sharing your expertise, Mr. Belitsky. Do you plot simple or exponential RSI's?

Igor Belitsky (Dec 22, 2005 10:18:48 AM)
Simple

Igor Belitsky (Dec 22, 2005 10:20:32 AM)
See at our today's system. Trend direction id based on MACD but entry levels (signals) come from RSI.

gamegirl (Dec 22, 2005 10:20:46 AM)
Can you give an example of what you said about defining entry levels, please?

Igor Belitsky (Dec 22, 2005 10:21:11 AM)
I just answered on this question. Next.

Suresh (Dec 22, 2005 10:24:02 AM)
How do we manange to avoid falling in the trap of trending market with RSI and Moving averages. Suresh

Igor Belitsky (Dec 22, 2005 10:25:05 AM)
There are no magic rules to avoid possible market traps

Igor Belitsky (Dec 22, 2005 10:27:46 AM)
You should always be ready to situation that your trading system start to produce series of losses

FXstreet Moderator (Dec 22, 2005 10:30:20 AM)
Dear attendees

FXstreet Moderator (Dec 22, 2005 10:30:38 AM)
we are experiencing technical problems

FXstreet Moderator (Dec 22, 2005 10:30:47 AM)
plese, keep posting yur questions

Kman (Dec 22, 2005 10:31:49 AM)
How we can avoid series of losses because, what I see as beginner, all of indicator become late to show us where the next move....

Igor Belitsky (Dec 22, 2005 10:33:00 AM)
Beginner are often expect the market to be completely predictable and easy. It's great mistake.

FXTrader (Dec 22, 2005 10:33:44 AM)
About the Trading System Example, how many trades you won / lost?

Igor Belitsky (Dec 22, 2005 10:35:40 AM)
The problem is that we have not yet programmed completed statistics to be shown. We only rely on equity chart to see how system is performed.

gamegirl (Dec 22, 2005 10:37:03 AM)
Hi Igor, I'm sending this msg on behalf of Ahmed (in his words), as he is having probs: 3 hrs. ago EUR/USD shows a rally a sudden rally so could mr Igore use it as an example, coz all analysts recommendations was to be at flat position. thnx.

Igor Belitsky (Dec 22, 2005 10:38:57 AM)
I expect this rally to wane around 1.1900. Be ready to sell from around 1.1900/10 stop 1.1960.

FXstreet Moderator (Dec 22, 2005 10:39:58 AM)
Please, post your questions again since when the connexion was lost, some of the today's questions were lost

FXstreet Moderator (Dec 22, 2005 10:40:01 AM)
thank you

gamegirl (Dec 22, 2005 10:40:42 AM)
What is the difference in using RSI over Stochastics, or is there any, and why would one choose one over the other? They seem to say the same thing.

Igor Belitsky (Dec 22, 2005 10:42:40 AM)
RSI(22) is more really repeats market moves while stochastics is only show market reversal points.

Kman (Dec 22, 2005 10:43:03 AM)
Mr. Igor, tell me about MACD and Bollinger Bands configuration that you use to trade. Thank you.

Igor Belitsky (Dec 22, 2005 10:44:06 AM)
MACD(13,26,9) BOB(10,1) on RSI(7,simple,close)

JSB (Dec 22, 2005 10:45:08 AM)
Do u use commodity prices to help forcast FX trends?

Igor Belitsky (Dec 22, 2005 10:45:54 AM)
No, we only rely on trading systems.

yass (Dec 22, 2005 10:47:33 AM)
depending on MCD to determine trend its lagging indicator and it will generate more false signals to work on???

Igor Belitsky (Dec 22, 2005 10:48:31 AM)
All MA based indicators are lagging. If you know indicator to predict trend reversals without lagging you would become richest man in the world within few weeks.

ahmed (Dec 22, 2005 10:50:03 AM)
how could we differentiate a breakout from a fakeout using rsi and BB

Igor Belitsky (Dec 22, 2005 10:51:51 AM)
It's up to you to develop this system. May be you will find additional filters to differentiate false break-outs from true ones.

Kman (Dec 22, 2005 10:53:07 AM)
Therefore, how we can predict the next move? Can you explain about your best trade management (stop loss, take profit)?

Igor Belitsky (Dec 22, 2005 10:55:10 AM)
There are millions of trading systems designed to predict next move. We use stop=60, target=90

FXstreet Moderator (Dec 22, 2005 10:55:35 AM)
LAST QUESTION

lickout (Dec 22, 2005 10:55:40 AM)
Can happen that system which works well in this yeat will not work next year?

Igor Belitsky (Dec 22, 2005 10:58:25 AM)
Yes, it happens quite often. You can get profits in this month but get losses in the next month. But not every person able to go through series of losses.

Igor Belitsky (Dec 22, 2005 10:59:38 AM)
There is special terminology for this ability. It's called AQ like well-known IQ.

Igor Belitsky (Dec 22, 2005 11:00:19 AM)
Adversity Quotinent

FXstreet Moderator (Dec 22, 2005 11:00:57 AM)
Thanks a lot, Igor

FXstreet Moderator (Dec 22, 2005 11:01:31 AM)
If your question was not answered during the course of this chat, please contact Igor at info@forexdealer.net

Igor Belitsky (Dec 22, 2005 11:02:29 AM)
Thank you for asking very good questions. Wish you good luck.

FXstreet Moderator (Dec 22, 2005 11:03:17 AM)
thank you so much for beign with us on today's Q&A Sessions

FXstreet Moderator (Dec 22, 2005 11:03:34 AM)
This was the last 2005

FXstreet Moderator (Dec 22, 2005 11:03:44 AM)
This was the last session for 2005

FXstreet Moderator (Dec 22, 2005 11:04:04 AM)
Q&A Session normal schedule from Monday to Friday will be resumed on January the 3rd.

FXstreet Moderator (Dec 22, 2005 11:04:41 AM)
Fxstreet.com Team would like to thank all of you your support during this year and we hope that you have really enjoyed our Sessions

FXstreet Moderator (Dec 22, 2005 11:05:24 AM)
I hopw to see you in all the Sessions for 2006 and do not forget stress how important feedback is for the continued success of our Live Q&A sessions.

FXstreet Moderator (Dec 22, 2005 11:05:27 AM)
In order for us to continue providing informative and educational Q&A Sessions, feedback is vital. Please feel free to post feedback about today's session, topic ideas, & suggestions. We would appreciate this very much. I will be logged on for a while. claire@fxstreet.com

FXstreet Moderator (Dec 22, 2005 11:05:45 AM)
Warmest regards and Happy Holydays to everyone.

FXstreet Moderator (Dec 22, 2005 11:05:56 AM)
See you in 2006!