It has been my experience that markets tend to trend over the intermediate and long term, but revert to the mean over the short term. In the short term, markets get extremely “oversold.” And when they do they tend to snap back quickly.
A favorite indicator I use to take advantage of short term oversold markets is the Relative Strength Index (RSI) developed by J. Welles Wilder. You can learn about the calculation and mechanics of RSI here.
I want to show you how I use it to generate profits:
The above chart is a daily bar chart for QQQ, the Exchange Traded Fund (ETF) for the Nasdaq 100. I like to use the 2-day RSI indicator for this strategy. And I like to buy when the 2-day RSI closes below 5 and sell when RSI closes above 50.
On Friday 9/25/09 RSI closed at 4.14 — a buy signal. QQQ closed that day at 41.70.
And look what happened on the very next trading day:
On Monday 9/28/09 RSI closed at 70.33 — a sell signal. QQQ closed at 42.41. A 1.7% profit in one trading day.
So the general rule is to buy when the 2-day RSI closes below 5 and sell when RSI closes above 50. Very simple.
Is the RSI reversal strategy always profitable? Of course not. Is it profitable enough to make it a profitable strategy overall? You betcha.
For members, I go into much more detail about using the RSI reversal strategy, including specific trades when they happen.
Wow, what a lengthy and in depth article but full of useful information