I checked out a book from my library on stock market technical analysis and was skeptical after fifty pages. The Relative Strength Index (RSI) seems simple and profitable, but where is the data backing it?
I returned the book and searched Google Scholar instead.
Disclaimer: This is not financial advice, and I am not a financial adviser.
TLDR: RSI is evidence-backed.
Before we get into support for that assertion, let’s first define RSI:
100−[100 / (1+[Average gain / Average loss])]
This formula was introduced by J. Welles Wilder Jr. in New Concepts in Technical Trading Systems (1978). Average loss/grain refers to a variable period of time. Most traders use 14 days.
The idea is simple: if RSI is above 70, the stock is “overbought,” and you should consider selling. If RSI is below 30, the stock is “oversold,” and you should consider buying. For shorthand, we’ll refer to a 14-day RSI where the trader buys at 30 and sells at 70 as “RSI(14, 30/70).”
Here was my criteria for choosing academic articles on RSI:
- Published no earlier than the year 2000.
- Included study of RSI(14, 30/70), RSI(N, 30/70) for some other time frame “N,” or RSI(N, 20/80). This excludes articles that did not separate results from RSI(N, 50/50).
- Isolated analysis of RSI, not combining it with other technical indicators.
- Used a trading method that could be replicated by a human. Apologies to Deng & Sakurai with their genetic evolutionary algorithm.
This will probably make academics cringe, but here was my method for weighting articles:
- Younger than five years, +2
- Younger than ten years, +1
Number of exchanges or indexes of companies tested:
- Greater than or equal to five, +3
- Greater than or equal to three, +2
- Greater than or equal to one, +1
Age of data (counting most recent year):
- Younger than five years, +3
- Younger than ten years, +2
- Younger than fifteen years, +1
R. Rosillo, D. de la Fuente & J. A. L. Brugos (2013) Technical analysis and the Spanish stock exchange: testing the RSI, MACD, momentum and stochastic rules using Spanish market companies, Applied Economics, 45:12, 1541–1550, DOI: 10.1080/00036846.2011.631894
- Used RSI(14, 30/70) on Madrid Stock Exchange from 1986 to 2009.
- Not completely clear how they define “total benefit,” but achieved a 112% total benefit from using RSI. In comparison, another well-known technical indicator, MACD, yielded 2.5% total benefit.
- Found RSI works best on IBEX-35 high-cap stocks.
- Total Score: +6 for RSI.
Chong, Terence T.-L.; Ng, Wing-Kam; Liew, Venus K.-S. 2014. “Revisiting the Performance of MACD and RSI Oscillators.” J. Risk Financial Manag. 7, no. 1: 1–12.
- Tested British FT 30, Italian Milan Comit General Index, American S&P/TSX Composite, American Dow Jones Industrial Average, German Dax 30, and Japanese Nikkei 225 Index with data from 1976 to 2002.
- Used many variations of RSI, including the classic RSI(14, 30/70).
- Found RSI works only a bit (around 1% return on transaction) in specific exchanges under certain conditions. I consider specificity of necessary circumstances a negative outcome.
- Total Score: -7 for RSI.
Terence Tai-Leung Chong & Wing-Kam Ng (2008) Technical analysis and the London stock exchange: testing the MACD and RSI rules using the FT30, Applied Economics Letters, 15:14, 1111–1114, DOI: 10.1080/13504850600993598
- Tested British FT 30 Index data from 1935 to 1994.
- Used RSI(14, 30/70).
- Found 0.778 10-day return on RSI buy signals (RSI drops below 30). This is a 22.44% annual profit.
- Found -0.127% 10-day return on RSI sell signals (RSI rises above 70). This is a 3.36% annual loss.
- After averaging the profits and losses, RSI is a win in my opinion.
- Total Score: +3 for RSI.
Coe, T.S. & Laosethakul, K. (2010). Should individual investors use technical trading rules to attempt to beat the market?. American Journal of Economics and Business Administration, 2(3), 201–209. doi: 10.3844/ajebasp.2010.201.209
- Tested the S&P 100, NASDAQ 100, and S&P Midcap 400 with data from 2000–2009.
- Used RSI(14, 70/30) but found RSI(3, 70/30) did significantly better with $13.84 vs $4.20 gains per share.
- Total Score: +5 for RSI.
Bhargavi, R. & Gumparthi, Srinivas & Anith, R.. (2017). Relative strength index for developing effective trading strategies in constructing optimal portfolio. International Journal of Applied Engineering Research. 12. 8926–8936.
- Tested 20 companies on the National Stock Exchange of India with data from 2011–2013. See article for details on the companies.
- Used RSI(14, 30/70).
- Harder to generalize the profits they achieved because data was displayed on a per-stock basis, but they were typically positive.
- Score: +5 for RSI
In summary, our total score for RSI is a positive 12. I suggest this is “approval from academia.”