Finding Consistent Trends with Strong Momentum - RSI for Trend-Following and Momentum Strategies

Abstract

Investors and traders typically use the Relative Strength Index (RSI) to find signals that help identify turning points in security prices. This strategy, however, discounts the true nature of the indicator and limits its potential. A breakdown of the RSI formula reveals that its power lies in its ability to identify consistent uptrends with strong momentum. Some practitioners use RSI ranges to identify existing trends and RSI extremes to signal momentum shifts. However, these approaches do not quantify how long RSI should hold its range, how regularly RSI should reach a momentum milestone and, most importantly, if RSI range and momentum indications have predictive value. The goal of this paper is to systematically test RSI range and momentum signals using stocks in the S&P 500. Moreover, this paper will show that the RSI range alone is inadequate because it does not always capture upside momentum. The RSI range measures trend consistency well, but a momentum component is needed to uncover the strongest uptrends. After quantifying and testing, this paper will provide evidence that signals combining an RSI bull range with RSI momentum can foreshadow sizable advances with good success rates. As such, these signals can be part of a successful investing strategy that combines trend-following and momentum.