RSI As An Exit Tool PDF
Preview RSI As An Exit Tool
Stocks & Commodities V. 9:4 (160-162): RSI As An Exit Tool by David Cartwright RSI As An Exit Tool by David Cartwright O ver the past 12 years of futures trading, I have taken a singular approach to the use of the relative strength index (see sidebar, "RSI"). I have discovered that RSI is unreliable for market entry. For exiting the market, however, the index can be very impressive. For traders who take multiple contracts in a futures market, using RSI can be even more dynamic. It is a common practice for traders to use a trailing stop order to protect profits on positions that are working in their favor. Many traders will use a simple moving average to locate the area in which to place a stop-loss order, then place their order under the average and move the stop as the moving average increases or decreases. That's the technique I use along with RSI to exit positions. Figure 1 is a chart of the Treasury bond market in a sideways pattern. I only use multiple contracts in the futures market, which allows me to be flexible enough to reduce my potential loss while still being able to participate in the potential profit of the transaction. Whenever the nine-day RSI rises into the 75 area, I liquidate 10% of my position, or at least one contract. If the RSI rises into the 80 area I will liquidate 50% of my remaining position, and if the RSI rises into the 90 area, I will liquidate 90% of my remaining position. These RSI levels have a history of indicating exhaustion of the buying for the price run. Obviously, the stronger the underlying fundamentals are, the higher the RSI could get, but even in strong bull markets, runs will tend to play out in regions above the 75 level. For the remainder of my position I will use a trailing stop. At RSI values of 75, I place the stop just under the nine-day moving average; at the RSI 80 level I move the stop to just under the four-day moving average, and at the RSI 90 level I raise the stop to just below the previous day's low. Conversely, if I am short in a sideways market, I will look for the RSI to decline into the 25 level, at which point I will liquidate 10% of my position or at least one contract. I will close out 50% of the Article Text Copyright (c) Technical Analysis Inc. 1 FIGURE 1: On the daily bar chart are plotted the numerical values from the RSI chart. Liquidate 10% of your position when RSI hits 75, 50% of the remaining at an RSI value of 80. FIGURE 2: During bull markets, positions should not be partially liquidated until the RSI reaches 80. Copyright (c) Technical Analysis Inc. FIGURE 3: Partial liquidation of profitable short positions is warranted when the RSI hits 25. Copyright (c) Technical Analysis Inc. Stocks & Commodities V. 9:4 (160-162): RSI As An Exit Tool by David Cartwright remaining position at the RSI 20 level and 90% at the RSI 15 level. Planning a strategy for market entry is only half the battle; you must also plan for protection and for market exit. SIMILAR STOP-LOSS ORDERS My stop-loss orders will also be tightened in a similar fashion; at the RSI 25 level, they will be just over the nine-day moving average, at the RSI 20 level, they will be just over the four-day moving average and at the RSI 15 level, just over the previous day's high. If my analysis indicates that I have entered a position in a bull market, I will wait to start liquidation until the RSI reaches the 80 area, but I will continue to follow the same stop-loss order scenario as indicated. If the RSI level reaches the 85 level I will liquidate at least 50% of my position and at the 90 level I will be 10% invested. In bear markets when the RSI reaches a level of 25 I will begin liquidation in the same fashion as I would in a bull market, after which the 20 and 15 levels become key. Again, the nine-day moving average and the four-day moving average values are areas to place stops. The previous day's high is my risk point if the RSI declines to the 15 level. Note that the area for very tight stops in a bear market is not at the same ratio as in a bull market; the reason is based on the history of my study of the RSI. It has been my experience that bear markets have a tendency to be more protracted and, especially after the initial decline, less severe than bull markets. Knowing this allows you to tighten your stop-loss orders or to liquidate your positions at levels that are not as steep in bear markets as in bull markets. Over the years, this system will ensure that profits can be taken when the market has had an extended run or a very steep price increase. The system, by virtue of the method of calculation, ensures that you have fewer positions in what should be considered high-risk areas. Also, the technique imposes a disciplined exit system on the trader and, perhaps most important, it is relatively simple to use. VARYING USES RSI has many more uses that have been discussed in other articles. The novice trader should avoid the temptation of trying to catch the tops and bottoms of markets using the RSI indicator, even though there are times when the RSI seems to provide such opportunities. In clearly defined directional moves, the RSI can stay at levels considered high or low for extended periods. Examples would be pork bellies in 1989 and interest rates in 1979; in November and December 1989 the pork bellies started a bull move that put the RSI indicator into the 90s for seven days in a row, and in 1979 the interest rate futures came under severe pressure and experienced a decline that pushed the RSI indicator to levels below 10 for as many as 10 days in a row. Many futures traders enter the market looking for that market to double or triple in price. As this rarely happens, many come out disappointed. If traders were more realistic and cautious about the way they trade, most would find more success. This realism and caution, however, should be part of a planned action. Planning a strategy for market entry is only half the battle; you must also plan for protection and Article Text Copyright (c) Technical Analysis Inc. 2 Stocks & Commodities V. 9:4 (160-162): RSI As An Exit Tool by David Cartwright for market exit. If you have felt the pangs of exit remorse, perhaps what you have learned about the relative strength index could make market decisions easier. David Cartwright has been a futures trader and broker for the past 15 years. Currently he is a financial consultant for futures firms in Taiwan. FOR FURTHER READING Wilder, J. Welles [1978].New Concepts in Technical Trading Systems, Trend Research. Copyright (c) Technical Analysis Inc. 3
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