Quite A Surprise (Again) on RSI !

I recall a friend/trader who is very obsessed with RSI (Relative Strength Index).  Everytime when we talk he would ask "what is the RSI on this date?", "what is the RSI on that date?" followed by his usual remark "ohhh, that's why it drop lah.." or "aha, that's why it goes up..".  For this friend of mine, I've put aside donchian style breakout in favor of RSI in this and subsequent post.

A very quick intro to RSI.  It is an oscillator which measures the relative strenght of the movement of prices.  Please google the rest on your own.  It can be programmed in excel as well, in my opinion, not as easy as MACD.

This time I do a backtest using RSI(14) using a very common strategy and default settings: go Long when RSI(14) crosses from below to above 30 (oversold), go Short when RSI(14) crosses from above to below 70 (overbought).  It is a Stop-and-Reverse(SAR) system where you square Long and turn Short at the same time and vice-versa.   The data used - Bursa FKLI continuous front-month EOD contract from Jan 1996 - Sep 2009.  Moeny management: basic 1 contract, SAR.

Heres the result...

And the equity curve (before cost) chart...

What a surprise, a common strategy that losses quite a lot of money!  Suddenly the ever so famous phrase "more than meets the eye" come into my mind.  In fact I can't even test with seed capital below RM90K !   A sure way to learn about risk of ruin!  If you look closely, the account has already blown up with the huge unrealised loss!  Ever wonder why people lose money trading purely on RSI using common strategy recommended by brokers, trading websites, books and seminars?

In my following post, I will try to find justice for this indicator by either using it as filters or optimize the parameters and see if I could get a robust and working trading system out of it.

Disclaimer: Taken from CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER OR OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.

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WHATEVER YOU READ HERE SHOULD BE USED AS LEARNING AIDS ONLY AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE. IF YOU DECIDE TO INVEST REAL MONEY, ALL TRADING DECISIONS ARE YOUR OWN RESPONSIBILITY.