4 Common Active Trading Strategies.
Active trading is the act of buying and selling securities based on short-term movements to profit from the price movements on a short-term stock chart. The mentality associated with an active trading strategy differs from the long-term, buy-and-hold strategy. The buy-and-hold strategy employs a mentality that suggests that price movements over the long term will outweigh the price movements in the short term and, as such, short-term movements should be ignored. Active traders, on the other hand, believe that short-term movements and capturing the market trend are where the profits are made. There are various methods used to accomplish an active-trading strategy, each with appropriate market environments and risks inherent in the strategy. Here are four of the most common types of active trading and the built-in costs of each strategy. (Active trading is a popular strategy for those trying to beat the market average. To learn more, check out How To Outperform The Market .)
Day trading is perhaps the most well known active-trading style. It's often considered a pseudonym for active trading itself. Day trading, as its name implies, is the method of buying and selling securities within the same day. Positions are closed out within the same day they are taken, and no position is held overnight. Traditionally, day trading is done by professional traders, such as specialists or market makers. However, electronic trading has opened up this practice to novice traders. (For related reading, also see Day Trading Strategies For Beginners .)
[ Learning which strategy is going to work best for you is one of the first steps you need to take as an aspiring trader . If you're interested in day trading, Investopedia Academy's Day Trader Course can teach you a proven strategy that includes six different types of trades. ]
Some actually consider position trading to be a buy-and-hold strategy and not active trading. However, position trading, when done by an advanced trader, can be a form of active trading. Position trading uses longer term charts - anywhere from daily to monthly - in combination with other methods to determine the trend of the current market direction. This type of trade may last for several days to several weeks and sometimes longer, depending on the trend. Trend traders look for successive higher highs or lower highs to determine the trend of a security. By jumping on and riding the "wave," trend traders aim to benefit from both the up and downside of market movements. Trend traders look to determine the direction of the market, but they do not try to forecast any price levels. Typically, trend traders jump on the trend after it has established itself, and when the trend breaks, they usually exit the position. This means that in periods of high market volatility, trend trading is more difficult and its positions are generally reduced.
When a trend breaks, swing traders typically get in the game. At the end of a trend, there is usually some price volatility as the new trend tries to establish itself. Swing traders buy or sell as that price volatility sets in. Swing trades are usually held for more than a day but for a shorter time than trend trades. Swing traders often create a set of trading rules based on technical or fundamental analysis; these trading rules or algorithms are designed to identify when to buy and sell a security. While a swing-trading algorithm does not have to be exact and predict the peak or valley of a price move, it does need a market that moves in one direction or another. A range-bound or sideways market is a risk for swing traders. (For more on swing trading, see our Introduction To Swing Trading .)
Scalping is one of the quickest strategies employed by active traders. It includes exploiting various price gaps caused by bid/ask spreads and order flows. The strategy generally works by making the spread or buying at the bid price and selling at the ask price to receive the difference between the two price points. Scalpers attempt to hold their positions for a short period, thus decreasing the risk associated with the strategy. Additionally, a scalper does not try to exploit large moves or move high volumes; rather, they try to take advantage of small moves that occur frequently and move smaller volumes more often. Since the level of profits per trade is small, scalpers look for more liquid markets to increase the frequency of their trades. And unlike swing traders, scalpers like quiet markets that aren't prone to sudden price movements so they can potentially make the spread repeatedly on the same bid/ask prices. (To learn more on this active trading strategy, read Scalping: Small Quick Profits Can Add Up . )
Costs Inherent with Trading Strategies.
There's a reason active trading strategies were once only employed by professional traders. Not only does having an in-house brokerage house reduce the costs associated with high-frequency trading, but it also ensures a better trade execution. Lower commissions and better execution are two elements that improve the profit potential of the strategies. Significant hardware and software purchases are required to successfully implement these strategies in addition to real-time market data. These costs make successfully implementing and profiting from active trading somewhat prohibitive for the individual trader, although not all together unachievable.
Active traders can employ one or many of the aforementioned strategies. However, before deciding on engaging in these strategies, the risks and costs associated with each one need to be explored and considered. (For related reading, also take a look at Risk Management Techniques For Active Traders .)

2 Common Strategies for Trading FX.
Swing trading, chart patterns, breakouts, and Elliott wave.
Range trading strategy is popular for buying low and selling high Trend following strategy is one of the most widely used strategies.
There are many benefits to trading FX such as a tremendous amount of liquidity with low transaction costs and margin requirements. The 24 hour nature of FX trading opens the door to a variety of strategies from day trading to position trading to range trading to trend trading .
There are so many different styles and flavors of FX traders , that they truly are too many to discuss each one . For now, we’ll start off with the two strategies that are the most common. The reason they are the most common is because they are opposite of one another…range trading and trend trading.
Range trading is a simple strategy where a trader will buy a currency on sale with the expectation that the valuation will come back towards a longer term average. This strategy may also be referred to as mean reversion and is similar to value investing.
Forex Strategy: How to Trade Ranges.
Created by J. Wagner.
One key to this strategy is identifying those price points that are more favorable for you. That means identifying a price level to enter where sellers stop selling and buyers are more likely to start buying. These price points are generally obtained by identifying levels of supply (resistance) and demand (support). Support and resistance levels can be easily obtained by performing technical analysis on the chart. Indicators and oscillators can help you time entries as well.
For more on how to trade ranges , check out James Stanley recent publication.
The second main strategy is trend following.
One of the most common strategies used by new and experienced traders is a trend following strategy. Trend following simply means identifying the direction prices have generally been moving, then place trades in that same direction.
Trend following is popular because strong trends tend to produce the largest results. Many times, those strong results came from moves in the direction of the preceding trend. Though there are several benefits, here are two benefits of trend trading .
Forex Strategy: Trading Strong Trends.
Created by J. Wagner.
Fortunately, trading trends is simple. The ease of identifying trades is in large part why new and experienced traders utilize some form of trend analysis in their trading plan.
If you are interested in trying out trading trends, but are unsure where to start, find out which of the three ways to trade a strong forex trend fits your personality the best.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX.
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Day Trading Strategies for Beginners.
A Beginners Day Trading Guide.
Check out my 2016 Trading Statistics.
Learn my Day Trading Tips and Techniques.
You need to understand basic day trading terminology & concepts to build your foundation. You can follow me on Youtube to get Free Education! Join the community of thousands of followers on YouTube and begin studying the free content we post on a daily basis. This is the beginning of your education. You need to study the markets, analyze charts, and learn the strategies professional traders are using every day.
A day trader is two things, a hunter of volatility and a manager of risk. The act of day trading is simply buying shares of a stock with the intention of selling those shares for a profit within minutes or hours. In order to profit in such a short window of time day traders will typically look for volatile stocks. This often means trading shares of companies that have just released news, reported earnings, or have another fundamental catalyst that is resulting in above average retail interest. The type of stocks a day trader will focus on are typically much different from what a long term investor would look for. Day traders acknowledge the high levels of risk associated with trading volatile markets and they mitigate those risks by holding positions for very short periods of time.
Day Trading with Cash vs. Margin.
Trading on Margin is when you trade with borrowed money (click here to details). For example, a day trader with a $25k trading account may use margin (buying power is 4x the cash balance) and trade as if he had $100k. This is considered leveraging your account. By aggressively trading on margin if he can produce 5% daily profits on the 100k buying power he will grow their 25k cash at the rate of 20% per day. The risk of course is that he will make a mistake that will cost him everything. Unfortunately, this the fate of 9 out of 10 traders. The cause of these career ending mistakes is a failure to manage risk.
Trading with Cash is an option, but because it requires 3 days for each trade to settle most traders will trade with a margin account but choose not to use leverage. This is a risk management technique.
All Day Trading Strategies Requires Risk Management.
Imagine a trader who has just taken 9 successful traders. In each trade there was a $50 risk and $100 profit potential. This means each trade had the potential to double the risk which is a great 2:1 profit loss ratio. The first 9 successful trades produce $900 in profit. On the 10th trade, when the position is down $50, instead of except the loss the untrained trader purchases more shares at a lower price to reduce his cost basis. Once he is down $100, he continues to hold and is unsure of whether to hold or sell. The trader finally takes the loss when he is down $1,000.
This is an example of a trader who has a 90% success rate but is still a losing trader because he failed to manage his risk. I can’t tell you how many times I’ve seen this happen. It’s more common than I bet you’d think. So many beginners fall into this habit of having many small winners then letting one huge loss wipe out all their progress. It’s a demoralizing experience, and it’s one that I’m very familiar with! We will discuss in detail how to identify stocks and find good trade opportunities, but first we will focus on developing your understanding of risk management.
Every Day Trade Needs a Max Loss (Cap your Losses)
Over my years as a trader and as a trading coach I have worked with thousands of students. The majority of those students experienced a devastating loss at some point due to an avoidable mistake. It’s easy to understand how a trader can fall into the position of a margin call (a debt to your broker). The money to trade on margin is easily available and the allure of quick profits can lead both new and seasoned traders to ignore commonly accepted rules of risk management.
The 10% of traders who consistently profit from the market share one common skill. They cap their losses. They accept that each trade has a pre-determined level of risk and the adhere to the rules they set for that trade. This is part of a well defined trading strategy. It’s common for an untrained trader to adjust their risk parameters mid-trader to accommodate a losing position. If for instance they said the stop is $50, when they are down $60 they said they’ll hold just a few more minutes. Before you know it, they are looking at an $80-100 loss and they are wondering how it happened.
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Learn the Top 2 Day Trading Strategies.
The Momentum and Reversal trading strategies are the #1 and #2 best trading strategies out there. These two day trading strategies are being used by thousands of our students who have participated in the Warrior Trading Day Trading Courses. In fact, in a survey of 100 of these students, over 80% are now trading profitably thanks to these strategies (click here for survey details) These strategies can be the basis for your $200/day trading plan.
We teach all the details of these strategies in our day trading course, but we also cover them in summary in several blog posts and in chat room Q&A sessions. You can read more about my Momentum Day Trading Strategy and my Reversal Day Trading Strategy. In short, both of these strategies are going to give you the framework for what type of stocks to trade, what time of day to trade, how to find stocks to trade, how to set your stop loss to have a max risk, and how to find your entry based on traditional chart patterns including Bull Flags and Rubber Band Snap Backs.
Momentum Day Trading Strategy.
Adopt a Trading Strategy & Master your Emotion.
Most of our students adopt either my Momentum or Reversal Day Trading Strategies. Once you choose the one that is a good match for your skill level, your risk management tolerance, and the time of day you plan to trade, you are ready to get started. Students in our Day Trading Course can download our written trading plan documents and I’m able to actually oversee them while they are trading.
Make a plan to trade this strategy in a Simulated Trading account for 1 month to test your skills. Your objects will be to achieve a percentage of success (or accuracy) of at least 60%. You also must maintain a profit loss ratio of at least 1:1 (winners are equal size on average as losers). If you can achieve these statistics, then you are positioned well to trade live. During the 1 month of practice, try to take 6 trades per day.
Reversal Day Trading Strategy.
Strategies for Maintaining Composure While Day Trading.
I admit that it’s extremely difficult to achieve the level of composure to sell when you hit your max loss on a trade. Nobody wants to lose, but the best traders are great losers. They accept their losses with grace and move on to the next trade. They never allow one trade the ability to destroy their account or their career. I personally focus on accepting small losses, and not letting them get me frustrated. Learning this characteristic will keep them in business as a day trader for a long time.
Your most important objective will be to follow your Max Loss rules so you never have a loss that exceeds a predetermined amount. The most important skill you need to learn is to cap your losses.
Big Winners & Small Losers requires Scaling.
Learning how to scale in and scale out of your day trades is a critical still every trader must develop. When I have winning trades, I scale out of the positions to take profits and adjust stops to break even as quickly as possible. I never hold a position that has achieved my profit target and hope for a bigger winner. The reason is because all too often the price can drop and you will end up giving up that profit. Instead, as soon as I’ve reached my first profit target (if I’m risking $100, then as soon as I’m up $100), I’ll sell 1/2 my position and set my stop at breakeven. This method of scaling out ensures small profits on all trades that move in your favor, giving you a better percentage of success.
One Students Success Story.
Hitting the Daily Goal & Profit Loss Ratios.
Lets say you take 6 trades/day with a $100 max loss and $100 profit targets. If lose on 2 and you win on 4 (about 65% success rate), and down $200 on losers, and up $400 on winners, giving you a net profit of $200/day. Ideally we want students to be risking $100, to make $200. That would give you a 2:1 profit loss ratio. Again, with 6 trades and a 2:1 profit loss ratio, your 2 losers would still be down $200, but your 4 winners would be $800 in profits, giving you a $600 net profit. With the same percentage of success, if you can increase your profit loss ratio you will make a lot more money!
Once you’ve hit your daily goal, decrease your position sizing so you don’t lose the goal. Finish the day green, and do it again tomorrow.
Maintain Your Accuracy By Being Disciplined.
As long as you can maintain accuracy of at least 60%, and maintain profit loss ratios of at least 1:1, you can be a profitable trader. Over time accuracy will improve and you will find yourself hitting winners right out of the gates. Some days you may even trade at 100% success with winners on all 6 trades you take.
If you plan to succeed, you must follow your trading plan. That means ONLY taking trades that fall into your strategy. Sometimes beginner traders start to gain confidence and then venture outside the strategy that works the best. This causes their accuracy to drop and profit loss ratios to go negative.
Focus on short term goals! You goal today is to take 6 trades, with 60%+ accuracy and 1:1 profit loss ratios. Rinse and repeat. That’s the ticket to success. Before you know it you will have 3-4 months of consistent trading under your belt.
Day Trader (Ross Cameron) on The Huffington Post.
Increasing position sizes.
For most students, once his or her accuracy has improved the next step is increasing positions sizes to maximize profits. If you’ve been trading at 65% success with 1:1 or 2:1 profit loss ratios for at least a couple of months you should be starting to feel pretty confident. Now it’s time to increase your position sizes. Since you’ve been working with a $100 max loss, you’ve probably rarely exceeded 2000 shares.
Now if we increase your max loss to $150, you can start to venture into larger size positions, and bigger daily goals. Remember that your daily goal is 2x your max loss per trade. So if your max loss is $100, your goal daily is $200. Max loss is $150, daily goal is $300. Personally, my max loss is $500 and my daily goal is $1000. I know some students who have a max loss as high as $5k/day. Even though it’s hard to imagine right now, that’s the potential of a strategy that is scalable! All the strategies we teach are scalable so whether you trade with a $5k account, a $50k account, or a $500k account, these strategies can be utilized.
What’s Next on your Day Trading Journey?
Now that I’ve taught you my 7 steps to trading success you are probably wondering what’s next! I would encourage you to join a live webinar with me so you can learn even more about my trading strategies. You can click here to join my next webinar, and make sure in the meantime you keep watching on YouTube! I put out tons of free content to help beginner traders getting started.
In Response to these awards, Warrior trading has been constantly pu in the spotlight as being an established educator in the finance sector.
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The guys at Warrior Trading has made a course that does not only contain a great strategy but it's also explained so it´s easy to understand.
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The transparency of Warrior Trading is one aspect that attracted me to them. They show you it all. They show you their losses as well as their gains. They are about showing you how to make a profit from the markets.
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Trading is hard, but warrior trading makes it easier. They keep a consistently friendly atmosphere, which you will find that after trading for a few years, you will appreciate.
Traders like consistency, and when you log on to Warrior Trading you can expect the same service as the day before. There are no surprises. These things are valuable.
They quietly establish an edge, make their money, and leave until the next day. Ross and his team are good guys, and if you were to subscribe to all the different services out there and compare them for 3 months, you would see WT at the top of the list.
I've always been passionate about trading but never really imagined this passion would have turned in a real, full-time job. In fact, I've never found any service which I really felt that would help me become a professional trader.
That is, until I met Warrior Trading. In particular, Ross has been really inspirational while I'm on my path to become a full-time day trader.
I always wanted to trade stocks but I saw all those numbers go up and down and I would always say to myself " I'm never going to get this". I looked at the free Youtube videos and I was hooked. It was the best investment i ever made.
Now I know how to day trade and the scare part about it is gone, I mean, I listened to them and paid for their paper trade and now i feel confident on what I'm doing with stocks.
I really mean this, I took time to write this because I really feel it in my heart that you guys are helping me accomplish my dream and that is to be a daytrader. Thank you warriortrading.
The courses are a must for whoever would like to make day trading a career.
I learn so many ways to help me save money and make money. The day I finished the course I did not have a losing day where I lost over $300 dollars!
My worst loss prior to the course was close to $15k. Ross helps you understand how the losses happen, the psychology behind it and how to prevent it ! I feel a lot more comfortable trading, because now I understand what stocks to pick, when to get in and out and how to manage my risk!!
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Popular trading strategies

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FXTM is presenting its first ever virtual seminar! Hosted by our renowned Head of Education, Andreas Thalassinos, attendees will have the opportunity to be part of his very first virtual classroom in Lagos. Explore the world of forex trading, get insights into the most popular trading strategies, and boost your trading potential.
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Participate in a virtual seminar with Andreas Thalassinos. Use the Alligator Strategy to ride the trend. Understand the statistics behind Bollinger Bands and their significance. Discover how to manage your risk exposure. Spot trending markets with ADX. Lock profits and exit positions according to your risk profile. Identify turning points in the market Combine strategies with technical indicators to filter entries in the market. Get your questions answered on the spot. Learn to trade with more confidence.
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Andreas Thalassinos (BSc, MSc, MSTA, CFTe, MFTA)
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Options strategies diagrams

Options Pricing: Profit and Loss Diagrams.

A profit and loss diagram, or risk graph, is a visual representation of the possible profit and loss of an option strategy at a given point in time. Option traders use profit and loss diagrams to evaluate how a strategy may perform over a range of prices, thereby gaining an understanding of potential outcomes. Because of the visual nature of a diagram, traders can evaluate the potential profit and loss – and the risk and reward of the position – at a glance.

To create a profit and loss diagram, values are plotted along the X and Y axes. The horizontal axis (the x-axis) shows the underlying prices, labeled in order with lower prices on the left and higher prices towards the right. The current underlying price is usually centered along this axis. The vertical axis (the y-axis) represents the potential profit and loss values for the position. The breakeven point (that indicates no profit and no loss) is usually centered on the y-axis, with profits shown above this point (higher along the y-axis) and losses below this point (lower on the axis). Figure 8 shows the basic structure of a profit and loss diagram.

The blue line (below) represents the potential profit and loss across the range of underlying prices. For simplicity, we'll begin by taking a look at a long stock position of 100 shares. Assume an investor buys 100 shares of stock for $25 each, or a total cost of $2,500. The diagram in Figure 9 shows the potential profit and loss for this position. When the blue line is on $25 (the cost per share), note that the profit and loss value is $0.00 (breakeven). As the stock price moves higher, so does the profit; conversely, as the price moves lower, the losses increase. Since there is, in theory, no upper limit to the stock's price, the graph line shows an arrow on one end.

With options, the diagram looks a bit different since your downside risk is limited to the premium you paid for the option. In the example shown in Figure 10, a call option has a strike price of $50 and a $200 cost (for the contract). The downside risk is $200 – the premium paid. If the option expires worthless (for example, the stock price was $50 at expiration), the loss would be $200, as shown by the blue line intersecting the y-axis at a value of negative 200. The breakeven point would be a stock price of $52 at expiration. In this case, the investor would "lose" $200 by paying the premium, which would be offset by the stock's rising price (equal to a $200 gain).

It should be noted that the above example shows a typical graph for a long call; each option strategy – such as long call butterflies and short straddles – has a "signature" profit and loss diagram that characterizes the profit and loss potential for that particular strategy. Figure 11, taken from the Options Industry Council's website, shows various options strategies and their corresponding profit and loss diagrams.

Most options trading platforms and analysis software let you create profit and loss diagrams for specific options. In addition, the charts can be created by hand, by using spreadsheet software such as Microsoft Excel, or by purchasing commercially available analysis tools.

How do I use a call option profit-loss diagram?

Options.

Introduction to profit-loss diagrams.

Diagrams aren’t just horrible, boring torture devises drawn by old Econ teachers on screechy chalk boards. We’ve been there.

For options, profit-loss diagrams are simple tools to help you understand and analyze option strategies before investing. When completed, a profit-loss diagram shows the profit potential, risk potential and breakeven point of a potential option play.

They’re drawn on grids, with the horizontal axis representing a range of stock prices that the underlying stock could go to and the vertical axis representing the corresponding profit or loss for the option investor on a per share basis.

Graphing stock.

Let’s warm up with a basic profit-loss diagram of a normal, purchased stock, because this will get us loose before diving into options diagrams.

Below (Graph 1) is a diagram of “long stock.” The term “long” means that the stock was purchased. It shows your profit or loss on one share of stock purchased for $39 (commissions not included). The blue line is your profit or loss, beginning on the left, where you have a loss, intersecting the X axis at $39, your break even, and rising to the right for share prices above $39, your profit zone.

Graphing a long call.

That was easy. Now let’s look at a “long call.” Graph 2 shows the profit and loss of a call option with a strike price of 40 purchased for 1.50 per share, or in Wall Street lingo, “a 40 Call purchased for 1.50.”

A quick comparison of Graphs 1 and 2 shows the differences between a long stock and a long call.

When buying a call, the worst case is that the share price doesn’t rise to the strike price and you lose only the cost of the call, 1.50 per share in this example. The horizontal line to the left of 40, the strike price, illustrates that loss. To the right of 40, the profit-loss line slopes up and to the right. Losses are incurred until the long call line crosses the horizontal axis, which is the stock price at which the strategy breaks even. In this example, the breakeven stock price is 41.50, which is calculated by adding the strike price of the call to the price of the call, or 40 + 1.50. Above 41.50, or to its right on the diagram, the long call earns a profit. Note that the diagram is drawn on a per-share basis and commissions are not included.

Graphing a short call.

Now for the third example - a “short call.” Graph 3 shows the profit and loss of selling a call with a strike price of 40 for 1.50 per share, or in Wall Street lingo, “a 40 Call sold for 1.50.”

The seller of the call has the obligation to sell the underlying shares of stock at the strike price of the call. Therefore, a short call has unlimited risk, because the stock price can rise indefinitely. The profit potential, however, is limited to the premium received when the call was sold.

The horizontal line to the left of 40, the strike price in this example, illustrates that the maximum profit is earned when the stock price at or below 40. To the right of 40, the profit-loss line slopes down and to the right. Profits are earned until the short call line crosses the horizontal axis, which is the stock price at which the strategy breaks even. In this example, the breakeven stock price is 41.50, which is calculated by adding the strike price of the call to the premium received for selling the call, or 40 + 1.50. Above 41.50, or to its right on the diagram, the short call incurs a loss. Note that the diagram is drawn on a per-share basis and commissions are not included.

These diagrams help investors in several ways, by:

Visualizing a strategy Revealing profit potential, risk, and the breakeven point Enabling comparisons to other strategies.

You see? That wasn’t so bad. Homework is optional in this class, but with a little practice you can learn to draw profit-loss diagrams and start your life as an options investor.

Related Lessons.

Now that you are ready to invest in options, be sure to understand a trading instruction.

In this video, you will learn how to use the Profit and Loss calculator to model options strategies to see profit and loss potential, change assumptions such as underlying price, volatility, or days to expiration, as well as how to trade directly from the calculator.

Options at Fidelity.

Options research helps identify potential option investments and trading ideas with easy access to pre-defined screens, analysis tools, and daily commentary from experts.

Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.

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Option Strategies.

Because options prices are dependent upon the prices of their underlying securities, options can be used in various combinations to earn profits with reduced risk, even in directionless markets. Below is a list of the most common strategies, but there are many more—infinitely more. But this list will give you an idea of the possibilities. Any investor contemplating these strategies should keep in mind the risks, which are more complex than with simple stock options, and the tax consequences, the margin requirements, and the commissions that must be paid to effect these strategies. One particular risk to remember is that American-style options — which are most options where the exercise must be settled by delivering the underlying asset rather than by paying cash — that you write can be exercised at any time; thus, the consequences of being assigned an exercise before expiration must be considered. (Note: The examples in this article ignore transaction costs.)

Option Spreads.

An option spread is established by buying or selling various combinations of calls and puts, at different strike prices and/or different expiration dates on the same underlying security. There are many possibilities of spreads, but they can be classified based on a few parameters.

A vertical spread (aka money spread) has the same expiration dates but different strike prices. A calendar spread (aka time spread, horizontal spread) has different expiration dates but the same strike prices. A diagonal spread has different expiration dates and strike prices.

The money earned writing options lowers the cost of buying options, and may even be profitable. A credit spread results from buying a long position that costs less than the premium received selling the short position of the spread; a debit spread results when the long position costs more than the premium received for the short position — nonetheless, the debit spread still lowers the cost of the position. A combination is defined as any strategy that uses both puts and calls. A covered combination is a combination where the underlying asset is owned.

A money spread , or vertical spread , involves the buying of options and the writing of other options with different strike prices, but with the same expiration dates.

A time spread , or calendar spread , involves buying and writing options with different expiration dates. A horizontal spread is a time spread with the same strike prices. A diagonal spread has different strike prices and different expiration dates.

A bullish spread increases in value as the stock price increases, whereas a bearish spread increases in value as the stock price decreases .

Example — Bullish Money Spread.

On October 6, 2006, you buy, for $850, 10 calls for Microsoft, with a strike price of $30 that expires in April, 2007, and you write 10 calls for Microsoft with a strike price of $32.50 that expires in April, 2007, for which you receive $200. At expiration, if the stock price stays below $30 per share, then both calls expire worthless, which results in a net loss, excluding commissions, of $650 ( $850 paid for long calls - $200 received for written short calls ). If the stock rises to $32.50, then the 10 calls that you purchased are worth $2,500 , and your written calls expire worthless . This results in a net $1,850 ( $2,500 long call value + $200 premium for short call - $850 premium for the long call ). If the price of Microsoft rises above $32.50, then you exercise your long call to cover your short call , netting you the difference of $2,500 plus the premium of your short call minus the premium of your long call minus commissions.

Ratio Spreads.

There are many types of option spreads: covered calls, straddles and strangles, butterflies and condors, calendar spreads, and so on. Most options spreads are usually undertaken to earn a limited profit in exchange for limited risk. Usually, this is accomplished by equalizing the number of short and long positions. Unbalanced option spreads , also known as ratio spreads , have an unequal number of long and short contracts based on the same underlying asset. They may consist of all calls, all puts, or a combination of both. Unlike other, better-defined, spreads, unbalanced spreads have many more possibilities; thus, it is difficult to generalize about their characteristics, such as reward/risk profiles. However, if long contracts exceed short contracts, then the spread will have unlimited profit potential on the excess long contracts and with limited risk. An unbalanced spread with an excess of short contracts will have limited profit potential and with unlimited risk on the excess short contracts. As with other spreads, the only reason to accept unlimited risk for a limited profit potential is that the spread is more likely to be profitable. Margin must be maintained on the short options that are not balanced by long positions.

The ratio in a ratio spread designates the number of long contracts over short contracts, which can vary widely, but, in most cases, neither the numerator nor the denominator will be greater than 5. A front spread is a spread where the short contracts exceed the long contracts; a back spread has more long contracts than short contracts. A front spread is also sometimes referred to as a ratio spread, but front spread is a more specific term, so I will continue to use front spread only for front spreads and ratio spreads for unbalanced spreads.

Whether a spread results in a credit or a debit depends on the strike prices of the options, expiration dates, and the ratio of long and short contracts. Ratio spreads may also have more than one breakeven point, since different options will go into the money at different price points.

Covered Call.

The simplest option strategy is the covered call, which simply involves writing a call for stock already owned. If the call is unexercised, then the call writer keeps the premium, but retains the stock, for which he can still receive any dividends. If the call is exercised, then the call writer gets the exercise price for his stock in addition to the premium, but he foregoes the stock profit above the strike price. If the call is unexercised, then more calls can be written for later expiration months, earning more money while holding the stock. A more complete discussion can be found at Covered Calls.

Example—Covered Call.

On October 6, 2006, you own 1,000 shares of Microsoft stock, which is currently trading at $27.87 per share. You write 10 call contracts for Microsoft with a strike price of $30 per share that expire in January, 2007. You receive . 35 per share for your calls, which equals $35.00 per contract for a total of $350.00 . If Microsoft doesn't rise above $30, you get to keep the premium as well as the stock. If Microsoft is above $30 per share at expiration, then you still get $30,000 for your stock, and you still get to keep the $350 premium .

Protective Put.

A stockholder buys protective puts for stock already owned to protect his position by minimizing any loss. If the stock rises, then the put expires worthless, but the stockholder benefits from the rise in the stock price. If the stock price drops below the strike price of the put, then the put's value increases 1 dollar for each dollar drop in the stock price, thus, minimizing losses. The net payoff for the protective put position is the value of the stock plus the put, minus the premium paid for the put.

Protective Put Payoff = Stock Value + Put Value – Put Premium.

Example—Protective Put.

Using the same example above for the covered call, you instead buy 10 put contracts at $0.25 per share , or $25.00 per contract for a total of $250 for the 10 puts with a strike of $25 that expires in January, 2007. If Microsoft drops to $20 a share, your puts are worth $5,000 and your stock is worth $20,000 for a total of $25,000. No matter how far Microsoft drops, the value of your puts will increase proportionately, so your position will not be worth less than $25,000 before the expiration of the puts—thus, the puts protect your position.

A collar is the use of a protective put and covered call to collar the value of a security position between 2 bounds. A protective put is bought to protect the lower bound, while a call is sold at a strike price for the upper bound, which helps pay for the protective put. This position limits an investor's potential loss, but allows a reasonable profit. However, as with the covered call, the upside potential is limited to the strike price of the written call.

Collars are one of the most effective ways of earning a reasonable profit while also protecting the downside. Indeed, portfolio managers often use collars to protect their position, since it is difficult to sell so many securities in a short time without moving the market, especially when the market is expected to decline. However, this tends to make puts more expensive to buy, especially for options on the major market indexes, such as the S&P 500, while decreasing the amount received for the sold calls. In this case, the implied volatility for the puts is greater than that for the calls.

Example—Collar.

On October 6, 2006, you own 1,000 shares of Microsoft stock, which is currently trading at $27.87 per share. You want to hang onto the stock until next year to delay paying taxes on your profit, and to pay only the lower long-term capital gains tax. To protect your position, you buy 10 protective puts with a strike price of $25 that expires in January, 2007, and sell 10 calls with a strike price of $30 that also expires in January, 2007. You get $350.00 for the 10 call contracts , and you pay $250 for the 10 put contracts for a net of $100. If Microsoft rises above $30 per share, then you get $30,000 for your 1,000 shares of Microsoft. If Microsoft should drop to $23 per share, then your Microsoft stock is worth $23,000, and your puts are worth a total of $2,000. If Microsoft drops further, then the puts become more valuable — increasing in value in direct proportion to the drop in the stock price below the strike. Thus, the most you'll get is $30,000 for your stock, but the least value of your position will be $25,000. And since you earned $100 net by selling the calls and writing the puts, your position is collared at $25,100 below and $30,100 . Note, however, that your risk is that the written calls might be exercised before the end of the year, thus forcing you, anyway, to pay short-term capital gains taxes in 2007 instead of long-term capital gains taxes in 2008.

Straddles and Strangles.

A long straddle is established by buying both a put and call on the same security at the same strike price and with the same expiration. This investment strategy is profitable if the stock moves substantially up or down, and is often done in anticipation of a big movement in the stock price, but without knowing which way it will go. For instance, if an important court case is going to be decided soon that will have a substantial impact on the stock price, but whether it will favor or hurt the company is not known beforehand, then the straddle would be a good investment strategy. The greatest loss for the straddle is the premiums paid for the put and call, which will expire worthless if the stock price doesn't move enough.

To be profitable, the price of the underlier must move substantially before the expiration date of the options; otherwise, they will expire either worthless or for a fraction of the premium paid. The straddle buyer can only profit if the value of either the call or the put is greater than the cost of the premiums of both options.

A short straddle is created when one writes both a put and a call with the same strike price and expiration date, which one would do if she believes that the stock will not move much before the expiration of the options. If the stock price remains flat, then both options expire worthless, allowing the straddle writer to keep both premiums.

A strap is a specific option contract consisting of 1 put and 2 calls for the same stock, strike price, and expiration date. A strip is a contract for 2 puts and 1 call for the same stock. Hence, straps and strips are ratio spreads. Because strips and straps are 1 contract for 3 options, they are also called triple options , and the premiums are less then if each option were purchased individually.

A strangle is the same as a straddle except that the put has a lower strike price than the call, both of which are usually out-of-the-money when the strangle is established. The maximum profit will be less than for an equivalent straddle. For the long position, a strangle profits when the price of the underlying is below the strike price of the put or above the strike price of the call. The maximum loss will occur if the price of the underlying is between the 2 strike prices. For the short position, the maximum profit will be earned if the price of the underlying is between the 2 strike prices. As with the short straddle, potential losses have no definite limit, but they will be less than for an equivalent short straddle, depending on the strike prices chosen. See Straddles and Strangles: Non-Directional Option Strategies for more in-depth coverage.

Example—Long and Short Strangle.

Merck is embroiled in potentially thousands of lawsuits concerning VIOXX, which was withdrawn from the market. On October, 31, 2006, Merck's stock was trading at $45.29, near its 52-week high. Merck has been winning and losing the lawsuits. If the trend goes one way or the other in a definite direction, it could have a major impact on the stock price, and you think it might happen before 2008, so you buy 10 puts with a strike price of $40 and 10 calls with a strike price of $50 that expire in January, 2008. You pay $2.30 per share for the calls , for a total of $2,300 for 10 contracts . You pay $1.75 per share for the puts , for a total of $1,750 for the 10 put contracts . Your total cost is $4,050 plus commissions. On the other hand, your sister, Sally, decides to write the strangle, receiving the total premium of $4,050 minus commissions.

Let's say, that, by expiration, Merck is clearly losing; it's stock price drops to $30 per share. Your calls expire worthless , but your puts are now in the money by $10 per share, for a net value of $10,000 . Therefore, your total profit is almost $6,000 after subtracting the premiums for the options and the commissions to buy them, as well as the exercise commission to exercise your puts. Your sister, Sally, has lost that much. She buys the 1,000 shares of Merck for $40 per share as per the put contracts that she sold, but the stock is only worth $30 per share, for a net $30,000. Her loss of $10,000 is offset by the $4,050 premiums that she received for writing the strangle. Your gain is her loss. (Actually, she lost a little more than you gained, because commissions have to be subtracted from your gains and added to her losses.) A similar scenario would occur if Merck wins, and the stock rises to $60 per share. However, if, by expiration, the stock is less than $50 but more than $40, then all of your options expire worthless, and you lose the entire $4,050 plus the commissions to buy those options. For you to make any money, the stock would either have to fall a little below $36 per share or rise a little above $54 per share to compensate you for the premiums for both the calls and the puts and the commission to buy them and exercise them.

Payoff Diagrams.

The best way to understand option strategies is to look at a diagram of how they behave.

Let's look again at the basics of a Call Option. Here is an example;

Type: Call Option.

Exercise Price: $25.

Expiry Date: 25th May (60 days until expiration)

Let's imagine that this option is worth $1.2. This means that the shares have to be trading at $26.20 for us to break even (Exercise Price of $25 plus the Option Premium of $1.20). If the shares are trading anywhere above $26.20 then we can start counting the profits. Anywhere below $26.20 and we lose out by the premium - $1.20. So, with a long call we have limited risk (the Option Premium) while at the same time having unlimited profit potential. Let's look at a graph of this concept;

The horizontal line across the bottom (the x-axis) represents the underlying instrument - in this example, the share price of Microsoft. The vertical axis illustrates our profit/loss as the shares move up or down.

The blue line is our payoff.

You can see that the vertical distance between the 0 profit line and the blue line is our maximum loss, i. e. the amount we paid for the option. So, anywhere under our break even point of $26.20 means that the option isn't profitable and we will not exercise and we will lose any premium we paid. If the market crashes and the stock goes bankrupt, our maximum loss will still only be the premium we paid.

However, as the shares trade past the $26.20 mark we start making money. If, at expiry, Microsoft shares are trading at $50 then we will make $23.80 per share.

How? Because we will exercise our right and have the seller of the option hand over Microsoft shares at a value of $25 (the exercise price). Minus the amount we have already paid for the option and we have a profit per share of $23.80.

What about if we sell a call option?

If the shares trade anywhere below $25 then we keep the $1.20 that we received when we sold the call option - the option premium.

However, if the market rallies then our losses become unlimited.

For more option payoff charts, be sure to check out the option strategies link. Or, to see option strategies in action, take a look at the option tutorials section.

Options 101 What are Options? Why Trade Options? Who Trades Options? Where are Options Traded? Option Types Option Style Option Value Volatility Time Decay In-The-Money? Payoff Diagrams Put Call Parity Weekly Options Delta Hedging Options Asset Types Index Option Volatility Option Currency Options Stock Options.

Comments (38)

Peter February 6th, 2017 at 4:11am.

Ali February 5th, 2017 at 4:10am.

I am sorry, But the "blue line" you talked about is the "Profit".

Its not the payoff. Payoff is the line which doesn't represent the impact of the Future values of costs and Premiums paid or received.

mahesh February 26th, 2015 at 5:02am.

Peter February 25th, 2015 at 6:54am.

mahesh February 25th, 2015 at 6:27am.

if i baught xyz call at 5 and after a week it is 25.but now it has no buyer at this value.

what should i do should i buy put of same strike prise ?

explain profits in that case.

Peter August 29th, 2012 at 7:19pm.

migh August 24th, 2012 at 3:06am.

suppose a stockm price is 40 and effective annual interest rate is 8%.draw a single payoff and profit diagram for the following option.

strike price is 35 with premium of 9.

Peter February 15th, 2012 at 10:17pm.

I'd say the best way to trade is to paper trade your ideas. If you don't want to wait until opening a brokerage account before testing then you can use an application like Visual Options Analyzer [link removed as the product no longer exists] where you can enter trades and manage them against downloaded option prices.

Jon February 15th, 2012 at 4:04pm.

So what would be the best way to just 'test the waters' without extreme risk of loosing a lot of money? The least risky version of options trading?

Peter February 6th, 2012 at 8:28pm.

If the option expires worthless, yes, you will always keep 100% of the premium received.

Jason February 6th, 2012 at 7:50pm.

If you sell short an option at $1.20 and the stock goes lower - the direction you intended you would most likely not walk with $120. Within the last 30 days to expiration, even in the money options can take a beating. You may only walk with $20. So, what is the best strategy? Buy to close with 15% profit?

Peter October 30th, 2011 at 6:13am.

Hi Steve, if the bond doesn't convert to anything (i. e. convert to a call option on the stock) then the payoff in this example would simply be the stock price plus $500 per year. Unless I have misunderstood?

Steve October 28th, 2011 at 9:34am.

Will someone please offer some help?

Peter October 12th, 2011 at 6:43pm.

Nancy October 12th, 2011 at 9:06am.

I'm struggling with how to arrive at a good strike price for a call. Does one ever choose, for instance, a strike price which is below the current stock price? As the price, goes up, I would still be profitable regardless of the strike price, right? Specifically, I'm looking at AMZN April 225 call. It is currently floating around that number now.

Peter September 5th, 2011 at 5:55pm.

Hi Gurko, if the price only reaches $26 then your loss would be less at $1.00 instead of $1.20.

Gurko September 5th, 2011 at 6:08am.

In the first example you said that if the price of the stock is below $26.20 you wouldn't exersize it and you will lose the premium that you paid ($1,20).

What if the price reaches $26 - wouldn't it be more profitable to exersize the option and to lose only $0.2 ?

Could you make that clear to me ?

Peter December 7th, 2010 at 9:09am.

What figures do you mean. the payoff charts? They are not currency specific. they are the same no matter what asset/currency the options are traded in.

nic December 7th, 2010 at 7:40am.

Hi, I was just wondering how recent these figures are? and do you how i would get hold of the british figures if possible?

Peter October 9th, 2010 at 6:41am.

It depends on your broker. Short positions require a margin, rather than just paying out the premium if you were to buy the option. A good guide, however, is to multiply the volume of contracts by the strike price and then multiplied by the contract size, which for US options is 100.

benjamin October 9th, 2010 at 2:48am.

i am looking to short uncovered options. i will be short selling 5-7 option contracts. how much $$$ would i need in my account?

Peter June 9th, 2010 at 12:37am.

Hi Dolf, the question Carter asks is in relation to a naked call, not a covered call - they have different payoff profiles. Sure, a covered call's losses is technically limited to the stock price going to zero. Not unlimited - but a lot.

Dolfandave June 8th, 2010 at 1:46pm.

Peter, As Carter mentione (two years ago:) in the first post below there is some question to "unlimited" losses. Yes if this is a naked call. I have been studying covered calls in my trek to learn options trading and if it were a covered call I personally don't view it as an unlimited loss. If I buy an OTM option as I understand this is the best technique w/ covered calls, then I will make the premium paid to me for writing the call plus the difference between the purchase price of my stock and the strike price. I don't think this is a bad deal nor would I really cry about it if I got called out in this situation. I wouldn't necessarily buy back the same security if I got called out. Your thoughts?

joel April 8th, 2010 at 1:54pm.

thanks guys i was struggling to understand the pay offs now it has become easy.

Peter June 11th, 2009 at 12:03pm.

henry June 9th, 2009 at 9:10am.

Hi, silly question im sure.

Peter May 21st, 2009 at 6:37am.

Rajeev May 20th, 2009 at 9:52pm.

This is very useful After going through the whole thing, I have a question. If I decide to exercise the call option, who is the other side, who is going to sell the stock. On the same thought, if I bought the call option for 1.20, sold it for 2.00 3 months later, at the time of maturity, if the buyer decides to exercise the right, am I supposed to provide the shares or the whoever wrote the call option originally.

Peter May 5th, 2009 at 7:32pm.

Tom May 5th, 2009 at 10:59am.

Sorry for the very basic question, but if you're buying an option priced at $1.20 as in the above example, are you physically paying $1.20, or is it multiplied by 100, i. e. $120?

Peter April 13th, 2009 at 7:01am.

Chuck April 11th, 2009 at 5:04pm.

If you intend to exercise your in the money call option and sell the stock immediately to realize your profit, would you also incur two stock trade fees as well as the original option purchase fee ? Are option trading fees similar to stock trading fees ?

Peter April 9th, 2009 at 7:42am.

The last trading day for April 09 options in the US is Friday the 17th. CBOE shows the 18th (Saturday) as the expiration date but Yahoo! is currently showing 17th when checking MSFT options. I couldn't see the 11th mentioned. I would say that's what it comes down to. "technically" they expire on the Saturday following the third Friday of the expiration month. But really Friday is the last trading day. i. e. you cannot get out of the option by trading it on a Saturday.

Jack April 8th, 2009 at 1:39pm.

april contracts on scottrade expire on 4/18. april contracts on yahoo financial expire on 4/11. I don't understand.

Admin October 9th, 2008 at 4:52am.

Queenie October 6th, 2008 at 7:44am.

"If, at expiry, Microsoft shares are trading at $50 then we will make $23.80 per share."

Admin October 3rd, 2008 at 8:43pm.

carter October 3rd, 2008 at 6:57pm.

Why would our options be unlimited if the market rallies in the last example? Wouldn't we only lose the price of the contract, as in the other scenario, if the stock doesn't go above $26.20?

Monsanto Company (MON)
MON » Topics » Stock Options:
We generally award stock options with ten year terms that vest ratably over three years, except in certain circumstances. In the event of a change of control, as defined on page 59, all options become fully vested. In the event of termination of employment for any reason before the first anniversary of the grant date, unvested options are forfeited. In the event of death, disability, involuntary termination without cause or retirement, options held more than one year become fully vested. Beginning with stock options granted for fiscal year 2009, we amended the Long-Term Incentive Plans to change the definition of retirement from age 50 to age 55, with five years of service. Retirement remains defined as age 50 for stock options granted prior to fiscal year 2009. The terms and conditions of the stock options provide for single-trigger vesting so that upon a change of control, employees are provided certainty as to their equity-based compensation and afforded the same flexibility as shareowners in determining whether to continue to be tied to the company’s success following the change in control.
We generally award stock options with ten year terms that vest ratably over three years, except in certain circumstances. In the event of a change of control, as defined on page 57, all options become fully vested. In the event of termination of employment for any reason before the first anniversary of the grant date, unvested options are forfeited. In the event of death, disability, involuntary termination without cause or retirement at age 50 or older, options held more than one year become fully vested. The terms and conditions of the stock options provide for single-trigger vesting so that upon a change of control, employees are provided certainty as to their equity-based compensation and afforded the same flexibility as shareowners in determining whether to continue to be tied to the company’s success following the change in control.

What Drives Monsanto Stock in 2017? (MON, BAYRY)
Depending on your point of view, Monsanto Company (MON), which ended 2016 with almost 7% returns compared with a 9.5% rise in the S&P 500 (SPX) index, either had a successful year or grossly underperformed.
While the St. Louis-based seeds company did trail the broader index, it's tough to ignore the fact that Monsanto navigated a tough agriculture industry, which suffered from a combination of low crop yields and weak prices, prompting many companies to seek M&A to survive. Monsanto, which last year agreed to be acquired by German company Bayer AG (BAYRY) for $66 billion, was no exception. With Monsanto shares still trading some 18% below Bayer's $128 per share offer price, there's still plenty of unrealized value in Monsanto stock. But can it get there? (See also: Monsanto Shareholders Back Bayer Deal .)
Monsanto stock closed Friday at $105.21, up 0.10%. Monsanto, which has positioned itself to produce in-demand seeds and weed-killing chemicals, seems poised to deliver positive earnings per share growth in 2017. In the most recent quarter, Monsanto's revenue surprised the market, growing 9% year over year, ending its streak of negative quarterly sales growth at four.
For the full year, the company's seed and genomics revenue totaled roughly $10 billion, marking the company's highest-grossing total. As a sign of strong fundamentals, Monsanto's operating costs remained mostly flat amid rising revenue, which suggests that the economics of the business have begun to work. But what does 2017 hold? (See also: Mega Deals: Why the Outlook Is Uncertain .)
The company now forecasts 2017 earnings in the range of $4.50 to $4.90 per share, which suggests year-over-year growth of 9.15%. Monsanto shares are currently priced at a forward P/E ratio of 22 based on fiscal 2017 estimates of $4.72 per share. The P/E puts Monsanto's valuation at about four points above the average stock in the S&P 500 index.
All told, Monsanto stock is not cheap, but with Bayer's $128 per share offer price still on the table, the risk-versus-reward favors owning Monsanto. And with President-elect Donald Trump's pro-business policies set to take effect, which increases the chances of the Bayer deal closing, Monsanto could be a way to grow the value in your portfolio. (See also: Who Are Monsanto's Main Competitors? )

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Monsanto stock options

Stocks: 15 minute delay (Bats is real-time), ET. Volume reflects consolidated markets. Futures and Forex: 10 or 15 minute delay, CT.
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Stocks: 15 minute delay (Bats is real-time), ET. Volume reflects consolidated markets. Futures and Forex: 10 or 15 minute delay, CT.
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Stacked View.
A Stacked view lists Puts and Calls one on top of the other, sorted by Strike Price.
Strike : The price at which the contract can be exercised. Strike prices are fixed in the contract. For call options, the strike price is where the shares can be bought (up to the expiration date), while for put options the strike price is the price at which shares can be sold. The difference between the underlying contract's current market price and the option's strike price represents the amount of profit per share gained upon the exercise or the sale of the option. This is true for options that are in the money; the maximum amount that can be lost is the premium paid. Last : The last traded price for the options contract. % From Last : The percent from the last price: (strike price - last / last) Bid : The bid price for the option. Midpoint : The midpoint between the bid and ask. Ask : The ask price for the option. Change: The difference between the current price and the previous day's settlement price. %Change: The difference between the current price and the previous day's settlement price, expressed as a percent. IV : Implied Volatility is the estimated volatility of the underlying stock over the period of the option. Volume : The total number of option contracts bought and sold for the day, for that particular strike price. Open Interest : Open Interest is the total number of open option contracts that have been traded but not yet liquidated via offsetting trades for that date.
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How do I use the Relative Strength Index (RSI) to create a forex trading strategy?
The relative strength index (RSI) is most commonly used to indicate temporary overbought or oversold conditions in a market. An intraday forex trading strategy can be devised to take advantage of indications from the RSI that a market is overextended and therefore likely to retrace.
The RSI is a widely used technical indicator, an oscillator that indicates a market is overbought when the RSI value is over 70 and indicates oversold conditions when RSI readings are under 30. Some traders and analysts prefer to use the more extreme readings of 80 and 20. A weakness of the RSI is that sudden, sharp price movements can cause it to spike repeatedly up or down, and, thus, it is prone to giving false signals. Also, it is not uncommon for price to continue to extend well beyond the point where the RSI first indicates the market as being overbought or oversold. For this reason, a trading strategy using the RSI works best when supplemented with other technical indicators.
The following is an intraday forex trading strategy that employs the RSI and at least one additional confirming indicator:
• Monitor the RSI for readings indicating the market is overbought or oversold.
• Consult other momentum or trend indicators for confirming signs of an impending retracement. For example, if the RSI shows oversold readings, a retracement to the upside is anticipated.
• Only initiate a trade looking to profit from a retracement if one these additional conditions is met:
1. The moving average convergence divergence (MACD) has shown divergence from price (for example, if price has made a new low, but the MACD has not and has turned from a downslope to an upslope), or.
2. The average directional index (ADX) has turned in the direction of a possible retracement.
• If the above conditions are met, then initiate the trade with a stop-loss order just beyond the recent low or high price, depending on whether the trade is a buy trade or sell trade, respectively.
• The initial profit target can be the nearest identified support/resistance level.

Rsi strategy

Developed by Larry Connors, the 2-period RSI strategy is a mean-reversion trading strategy designed to buy or sell securities after a corrective period. The strategy is rather simple. Connors suggests looking for buying opportunities when 2-period RSI moves below 10, which is considered deeply oversold. Conversely, traders can look for short-selling opportunities when 2-period RSI moves above 90. This is a rather aggressive short-term strategy designed to participate in an ongoing trend. It is not designed to identify major tops or bottoms. Before looking at the details, note that this article is designed to educate chartists on possible strategies. We are not presenting a standalone trading strategy that can be used right out of the box. Instead, this article is meant to enhance strategy development and refinement.
There are four steps to this strategy and levels are based on closing prices. First, identify the major trend using a long-term moving average. Connors advocates the 200-day moving average. The long-term trend is up when a security is above its 200-day SMA and down when a security is below its 200-day SMA. Traders should look for buying opportunities when above the 200-day SMA and short-selling opportunities when below the 200-day SMA.
Second, choose an RSI level to identify buying or selling opportunities within the bigger trend. Connors tested RSI levels between 0 and 10 for buying, and between 90 and 100 for selling. Connors found that returns were higher when buying on an RSI dip below 5 than on an RSI dip below 10. In other words, the lower RSI dipped, the higher the returns on subsequent long positions. For short positions, the returns were higher when selling-short on an RSI surge above 95 than on a surge above 90. In other words, the more short-term overbought the security, the greater the subsequent returns on a short position.
The third step involves the actual buy or sell-short order and the timing of its placement. Chartists can either watch the market near the close and establish a position just before the close or establish a position on the next open. There are pros and cons to both approaches. Connors advocates the before-the-close approach. Buying just before the close means traders are at the mercy of the next open, which could be with a gap. Obviously, this gap can enhance the new position or immediately detract with an adverse price move. Waiting for the open gives traders more flexibility and can improve the entry level.
The fourth step is to set the exit point. In his example using the S&P 500, Connors advocates exiting long positions on a move above the 5-day SMA and short positions on a move below the 5-day SMA. This is clearly a short-term trading strategy that will produce quick exits. Chartists should also consider setting a trailing stop or employing the Parabolic SAR. Sometimes a strong trend takes hold and trailing stops will ensure that a position remains as long as the trend extends.
Where are the stops? Connors does not advocate using stops. Yes, you read right. In his quantitative testing, which involved hundreds of thousands of trades, Connors found that stops actually “hurt” performance when it comes to stocks and stock indices. While the market does indeed have an upward drift, not using stops can result in outsized losses and large drawdowns. It is a risky proposition, but then again trading is a risky game. Chartists need to decide for themselves.
Trading Examples.
The chart below shows the Dow Industrials SPDR (DIA) with the 200-day SMA (red), 5-period SMA (pink) and 2-period RSI. A bullish signal occurs when DIA is above the 200-day SMA and RSI(2) moves to 5 or lower. A bearish signal occurs when DIA is below the 200-day SMA and RSI(2) moves to 95 or higher. There were seven signals over this 12-month period, four bullish and three bearish. Of the four bullish signals, DIA moved higher three of the four times, which means these signals could have been profitable. Of the three bearish signals, DIA moved lower only once (5). DIA moved above the 200-day SMA after the bearish signals in October. Once above the 200-day SMA, the 2-period RSI did not move to 5 or lower to produce another buy signal. As far as a gain or loss, it would depend on the levels used for the stop-loss and profit taking.
The second example shows Apple (AAPL) trading above its 200-day SMA for most of the timeframe. There were at least ten buy signals during this period. It would have been difficult to prevent losses on the first five because AAPL zigzagged lower from late February to mid-June 2011. The second five signals fared much better as AAPL zigzagged higher from August to January. Looking at this chart, it is clear that many of these signals were early. In other words, Apple moved to new lows after the initial buy signal and then rebounded.
As with all trading strategies, it is important to study the signals and look for ways to improve the results. The key is to avoid curve fitting, which decreases the odds of success in the future. As noted above, the RSI(2) strategy can be early because the existing moves often continue after the signal. The security can continue higher after RSI(2) surges above 95 or lower after RSI(2) plunges below 5. In an effort to remedy this situation, chartists should look for some sort of clue that prices have actually reversed after RSI(2) hits its extreme. This could involve candlestick analysis, intraday chart patterns, other momentum oscillators or even tweaks to RSI(2).
RSI(2) surges above 95 because prices are moving up. Establishing a short position while prices are moving up can be dangerous. Chartists could filter this signal by waiting for RSI(2) to move back below its centerline (50). Similarly, when a security is trading above its 200-day SMA and RSI(2) moves below 5, chartists could filter this signal by waiting for RSI(2) to move above 50. This would signal that prices have indeed made some sort of short-term turn. The chart above shows Google with RSI(2) signals filtered with a cross of the centerline (50). There were good signals and bad signals. Notice that the October sell signal did not go into effect because GOOG was above the 200-day SMA by the time RSI moved below 50. Also, note that gaps can wreak havoc on trades. The mid-July, mid-October and mid-January gaps occurred during earnings season.
Conclusions.
The RSI(2) strategy gives traders a chance to partake in an ongoing trend. Connors states that traders should buy pullbacks, not breakouts. Conversely, traders should sell oversold bounces, not support breaks. This strategy fits with his philosophy. Even though Connors' tests show that stops hurt performance, it would be prudent for traders to develop an exit and stop-loss strategy for any trading system. Traders could exit longs when conditions become overbought or set a trailing stop. Similarly, traders could exit shorts when conditions become oversold. Keep in mind that this article is designed as a starting point for trading system development. Use these ideas to augment your trading style, risk-reward preferences, and personal judgments. Click here for a chart of the S&P 500 with RSI(2).
Suggested Scans.
RSI(2) Buy Signal.
This scan searches for stocks that have just had an RSI(2) Buy Signal.
RSI(2) Sell Signal.
This scan searches for stocks that have just had an RSI(2) Sell Signal.
Further Study.
From the creators of the RSI(2) strategy, this book details more trading strategies and includes a chapter on exits. Connors also shows the details of his back-tests and provides guidelines to improve trading results.

RSI And How To Profit From It.
We all know there are no magic indicators but there is one that certainly acted like magic over the past 10 years or so. What indicator is it? Our reliable RSI. In this article we are going to look at two trading models that were first talked about in the book, “Short Term Trading Strategies That Work” by Larry Connors and Cesar Alvarez. It has been well established in various articles that a 2-period RSI on the daily chart of the stock index markets has been a fantastic tool for finding entry points. Sharp price drops in the S&P E-Mini futures during bullish markets have historically (since the year 2000) been followed by reversals. These reversals can often be detected by using the standard RSI indicator with a period value of two. Place this indicator on a daily chart and look for points when the indicator falls below five, for example. These extreme low points are buying opportunities.
Values below 5 are green. These are buy points.
RSI(2) System.
We can turn this into a simple trading model to test the effectiveness of the RSI(2) indicator on the E-mini S&P. In short, we wish to go long on the S&P when it experiences a pullback in a bull market. We can use a 200-day simple moving average to determine when we are in a bull trend and using a 2-period RSI to locate high probability entry points. We can then exit when price closes above a 5-day simple moving average. The rules are clear and simple:
Price must be above its 200-day moving average. Buy on close when cumulative RSI(2) is below 5. Exit when price closes above the 5-day moving average. Use a $1000 catastrophic stop loss.
The system backtest was performed from September 1997 through March 2012. A total of $50 for commissions and slippage was deducted per round trip. Below is a chart of what this system would look like along with the system results.
RSI(2) System Results.
Percent Winners: 67%
These results are great considering we have such a simple system. This demonstrates the power the RSI(2) indicator has had now for well over a decade. Just with this concept alone you can develop several trading systems. For now, let’s see if we can we improve upon these results.
Accumulated RSI(2) Strategy.
Larry Conners adds a slight twist to the RSI(2) trading model by creating an accumulated RSI value. Instead of a single calculation we will be computing a running daily total of the 2-period RSI. In this case, we are going to use the total of the 2-period RSI for the past three days. When you keep an accumulated value of the RSI(2) you smooth out the values. Below is a chart comparing the standard 2-period RSI indicator with an accumulated 2-period RSI indicator. You can see how much smoother our new indicator is. This is done to reduce the number of trades in hopes of capturing the quality trades. In short, it’s an attempt to improve the efficiency of our original trading model.
Accumulated RSI in top pane. Standard RSI in lower pane.
Price must be above its 200-day moving average. Buy on close when cumulative RSI(2) of the past three days is below 45. Exit when RSI(2) of the close of current day is above 65. Use a $1000 catastrophic stop loss.
Accumulated RSI(2) System Results.
Percent Winners: 67%
S&P Cash Market.
What would the 2-period RSI system look like trading 100 shares of the S&P cash market going back to 1993? It does rather well.
Conclusions.
So which one is better? The accumulated strategy worked as intended. It increased the efficiency of the standard RSI(2) trading model by reducing the number of trades, yet produced about the same amount of net profit. As a bonus, the drawdown was slightly smaller. While both systems do a fantastic job, the accumulation strategy may do a slightly better job. The Accumulated RSI(2) strategy will work well on the mini Dow as well as the two ETFs, DIA and SPY.
The EasyLanguage code is available below as a free download. There is also a TradeStation workspace. Please note, the trading concept and the code as provided is not a complete trading system. It is simply a demonstration of a robust entry method that can be used as a core of a trading system. So, for those of you who are interested in building your own trading systems this concept may be a great starting point.
Get The Book.
TradeStation RSI(2) WorkSpace.
2013 Update:
An additional article was published in 2013 which updates the RSI system and explores it in more detail. Read it here.
About the Author Jeff Swanson.
Jeff is the founder of System Trader Success – a website and mission to empowering the retail trader with the proper knowledge and tools to become a profitable trader the world of quantitative/automated trading.
Related Posts.
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Popular posts.
Connors 2-Period RSI Update For 2013.
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The Ivy Portfolio.
Improving The Simple Gap Strategy, Part 1.
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R&D Blog.
I. Trading Strategy.
Developer: Larry Connors (The 2-Period RSI Trading Strategy), Welles Wilder (The RSI Momentum Oscillator). Source: (i) Connors, L., Alvarez, C. (2009). Short Term Trading Strategies That Work . Jersey City, NJ: Trading Markets; (ii) Wilder, J. W. (1978). New Concepts in Technical Trading Systems . Greensboro: Trend Research. Concept: The long equity trading system based on the 2-Period RSI (Relative Strength Index). Research Goal: Performance verification of the simple trading strategy that buys pullbacks in a bull market. Specification: Table 1. Results: Figure 1-2. Trade Filter: The 2-Period RSI closes below RSI_Threshold (Default Value: RSI_Threshold = 5). Portfolio: Five equity futures markets (DJ, MD, NK, NQ, SP). Data: 36 years since 1980. Testing Platform: MATLAB®.
II. Sensitivity Test.
All 3-D charts are followed by 2-D contour charts for Profit Factor, Sharpe Ratio, Ulcer Performance Index, CAGR, Maximum Drawdown, Percent Profitable Trades, and Avg. Win / Avg. Loss Ratio. The final picture shows sensitivity of Equity Curve.
Tested Variables: RSI_Threshold & Exit_Look_Back (Definitions: Table 1):
Figure 1 | Portfolio Performance (Inputs: Table 1; Commission & Slippage: $0).
The Relative Strength Index (RSI) is a momentum oscillator that compares the magnitude of recent gains to recent losses to determine overbought and oversold conditions.
RSI(Close, RSI_Look_Back) is the Relative Strength Index of the close price over a period of RSI_Look_Back;
Default Value: RSI_Look_Back = 2.
We use an exponential smoothing.
Up[i] = max(Close[i] − Close[i − 1], 0);
Down[i] = max(Close[i − 1] − Close[i], 0);
AvgUp[i] = (AvgUp[i − 1] * (RSI_Look_Back − 1) + Up[i]) / RSI_Look_Back;
AvgDown[i] = (AvgDown[i − 1] * (RSI_Look_Back − 1) + Down[i]) / RSI_Look_Back;
RS[i] = AvgUp[i] / AvgDown[i];
RSI[i] = 100 − 100/(1 + RS[i]);
The first “AvgUp” (i. e. AvgUp[1] ) is calculated as a simple average of “Up” values over a period of RSI_Look_Back.
The first “AvgDown” (i. e. AvgDown[1]) is calculated as a simple average of “Down” values over a period of RSI_Look_Back.
MA(Close, Setup_Look_Back) is a simple moving average of the close price over a period of Setup_Look_Back;
Default Value: Setup_Look_Back = 200;
Setup Rule: Close[i] > MA[i];
The RSI closes below RSI_Threshold;
Default Value: RSI_Threshold = 5;
Filter Rule: RSI[i] < RSI_Threshold;
A buy at the open is placed after a bullish Setup/Filter.
Note: In the original model, a buy at the close is placed on the same bar as a bullish Setup/Filter.
Default Value: Exit_Look_Back = 5.
Long Exit: A sell at the open is placed if Close[i − 1] > MA[i − 1];
Stop Loss Exit: ATR(ATR_Length) is the Average True Range over a period of ATR_Length. ATR_Stop is a multiple of ATR(ATR_Length). Long Stop: A sell stop is placed at [Entry − ATR(ATR_Length) * ATR_Stop].
Exit_Look_Back = [5, 30], Step = 1.
Portfolio = 5 Equity Futures (DJ, MD, NK, NQ, SP)
ATR_Stop = 6 (ATR.
Average True Range)
Table 1 | Specification: Trading Strategy.
III. Sensitivity Test with Commission & Slippage.
Tested Variables: RSI_Threshold & Exit_Look_Back (Definitions: Table 1):
Figure 2 | Portfolio Performance (Inputs: Table 1; Commission & Slippage: $50 Round Turn).
IV. Benchmarking.
We benchmark the base case strategy (default parameters) against alternatives:
Case #1: RSI_Threshold = 5; Exit_Look_Back = 5 (Base Case).
Case #2: RSI_Threshold = 5; Exit_Look_Back = 10.
Case #3: RSI_Threshold = 10; Exit_Look_Back = 10.
Case #4: RSI_Threshold = 15; Exit_Look_Back = 10.
Table 2 | Inputs: Table 1; Fixed Fractional Sizing: 1%; Commission & Slippage: $50 Round Turn.
V. Research.
Connors, L., Alvarez, C. (2009). Short Term Trading Strategies That Work . Jersey City, NJ: Trading Markets:
Most traders use the 14-period RSI. But our studies have shown that statistically, there is no edge using the 14-period RSI . However, when you shorten the time frame of the RSI (meaning you go much lower than the 14-period) you start seeing some very impressive results. Our research shows that more robust and consistent results are obtained by using a 2-period RSI and we have built many trading methods that incorporate the 2-period RSI […] The lower the RSI, the greater the performance. The average returns of stocks with a 2-period RSI reading below 2 were greater than those stocks with a 2-period RSI reading below 5, etc.
VI. Rating: Relative Strength Index (RSI) Model | Trading Strategy.
VII. Summary.
(i) The trading strategy based on the 2-Bar Relative Strength Index underperforms alternative momentum models; (ii) The preferred parameters are: 5 ≤ RSI_Threshold ≤ 13; 8 ≤ Exit_Look_Back ≤ 13 (Figure 1-2).
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.
RISK DISCLOSURE: U. S. GOVERNMENT REQUIRED DISCLAIMER | CFTC RULE 4.41.
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RSI indicator trading strategy, 5 systems + back test results!
RSI indicator trading strategy – 5 systems.
Digging into the quintessential overbought oversold indicator!
The RSI indicator is a cruel mistress!
She lure’s us in with promises of easy money and trading success,
only to drain your trading account balance in a run of terrible stoploss strikes, Even thought the indicator said BUY!
Oscillator indicators in general, are risky and unreliable beasts.
They might look friendly and approachable at first, only to BITE your hand off just when you are most comfortable!
The RSI indicator is usually the go to oscillator for the novice trader when deciding to enter that first trade.
There is a simple, valid reason for this;
The RSI indicator is simple to read and understand.
and it “APPEARS” to get great results when given the visual back-test!
( Come on, admit it, we have all done it! We take a quick glance at the RSI indicator in search of that sweet confirmation bias when we are just itching to make a trade. )
It is almost impossible to resist the siren call of a trading signal from our favorite indicator.
But approaching trading in a passive fashion like this is dangerous and will lead to the destruction of your account eventually!
In this article I will teach you how to avoid some of the major pitfalls that beset most beginner traders when it comes to the RSI indicator.
I am going to show you a few important things:
I am going to break down the RSI indicator so you understand it from head to toe. I will explain the top 5 RSI trading strategies that we hear so much about, what they mean and how to trade using them. I will back test each of those strategies against the EURCHF over a 16 month period and see how they actually performed, using a sample starting account of $1000, and a sensible stoploss strategy.
After reading this article you will Know the RSI indicator inside out,
YOU WILL BE better informed on the risks of using each of the RSI trading strategies to generate trading signals,
the next time the siren calls, you will think twice about placing that trade!
relative strength index calculation.
These are the nitty gritty details on how the RSI indicator is built.
In reality your charting software will do this calculation for you, thats what technology is for!
1: Pick the base number of periods on which to base the study.
2: compare todays closing price with yesterdays.
3: add all the upward movements in points between closing prices.
4: add all the downwards movements between closing prices.
5: calculate the EMA ( exponential moving average ) of the upward and downward price movements.
6: calculate the relative strength,
RS = EMA Upward Price Movements / EMA Downward Price Move ments.
7: Calculate the Relative Strength Index (RSI):
RSI definition, what does it all mean for my trading?
The RSI indicator Has definitely got one up over its competing oscillator in the fact that it has fixed points extremes at 0 and 100.
Rather than the relative floating extremes of say the Momentum or Rate of change oscillators.
In that sense it does give the trader a base to work from in judging one period of market action to another.
The RSI indicator is also smoother than it’s big brothers, Because it uses the Exponential moving average, it tends to be less jumpy and more consistent.
In general the RSI is interpreted as follows;
If the indicator is below 30, then the price action is considered weak and possibly oversold.
If it is reading above 70, then the asset is after a strong uptrend and could be overbought.
Because the RSI is used as a tool to indicate extremes in price action, then the temptation is to use it to place contrarian trades,
Buying when the indicator crosses 30 to the upside means you are counting on the trend reversing and then profiting from it. The same is true for selling when the RSI crosses down below 70 and using this a sign that the market is reversing from a strong uptrend.
Life is never that simple though, and more often than not, you will find that the risk involved in this type of simplistic approach is ruinous to you account balance.
New traders tend to gravitate to the RSI when attempting to delve into analysis for the first time.
It is easy to aproach and easy to understand, it has fixed overbought and oversold levels and it tends to be correct over longer periods,
I can see why it is so attractive to all of us,
However, you cannott ignore the hugh failings of the RSI indicator in a strong trend!
It can stay at 90 for days on end,
dancing above the overbought line like it is on speed at a london rave in 1992!
This is no good to the novice trader who pressed the sell button without placing a stop!
Some of us (like myself ) can only learn the hard way!
Here are some quick lessons:
Wait for conformation before considering a trade,
The RSI can remain at extreme levels for long periods in a strong trend.
Dont jump right in when you see a reading of 90, first allow the RSI line to fall back below the overbought line to at least give a stoploss level to trade off .
Watch the Centreline for trend confirmtion.
If the RSI line reaches an extreme and then returns to the centreline it is a better indication of a turning point in the trend. Waiting for this to occur can cut out those nasty impulsive trades!
It is common for technical traders to watch the centreline to show shifts in trend,
If the RSI is above 50, then it is considered a bullish uptrend, and if its below 50, then a bearish downtrend is in play.
Simple RSI strategy back test:
Over the last year of trading in EUR/CHF there has been:
From the conventional viewpoint, this means the trader got 5 sell signals and 3 buy signals.
Lets see how that worked out for him!
the RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
this signal led to a 300 point rise without triggering a 50 point stop loss.
that’s a 300 point gain in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 150 point rise.
the market triggered a 50 point stop loss.
that’s a 50 point loss in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 400 point rise in the market!
the market triggered a 50 point stop loss.
that’s a 50 point loss in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 150 point rise in the market!
the market triggered a 50 point stop loss.
that’s another 50 point loss in your account!
The trader uses this signal as an opportunity to sell the market.
this signal led to a 250 point rise in the market!
the market triggered a 50 point stop loss.
that’s another 50 point loss in your account!
the RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
this signal led to a 220 point rise without triggering a 50 point stop loss.
that’s a 220 point gain in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 130 point rise in the market!
the market triggered a 50 point stop loss.
that’s a 50 point loss in your account!
the RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
this signal led to a 100 point decline.
while triggering a 50 point stop loss.
that’s a 50 point loss in your account!
In total the trader made 220 point gain in their trading account over 8 trades.
This was done with 2 winning trades and 6 loosing trades.
How to use rsi indicator in forex trading.
In order to get real value from the RSI indicator and take advantage of its benefits,
You need to approach it cautiously and interpret it a little deeper.
Here are a few techniques that you can use to cut out a lot of false signals.
Failure swings;
As I mentioned above,
The problem faced by every trader who uses the RSI indicator is that the market may well continue in its trend despite the fact that it hit an extreme reading,
It might even go on to leave that price level behind in the distance depending on the strength of the trend.
For this reason there came about the concept of the failure swing, in order to interpret the index better.
There is both the bearish and bullish failure swing.
A ‘bearish failure swing’ happens when the RSI enters the overbought zone at 70 and then comes back down below the 70 mark again.
In this case, a short position will be entered only after the RSI cuts down through the 70 line from the top.
The ‘bullish failure swing’ occurs when the RSI enters the oversold zone at 30 and then rallies out again and rises above the 30 line again.
The trader uses this rise above the 30 line as a trigger to go long.
Divergence:
Positive divergence happens when the price of an asset is drifting lower yet the RSI is starting to trend higher.
This could mean that the price is nearing a bottom and will probably turn up soon.
Negative divergence happens the opposite way, the price is driving higher, but the RSI has stalled and is beginning to turn lower.
When this occurs it is likely that the price will stop rising soon after. And then follow the RSI lower.
Trend confirmation:
The RSI can be useful as a tool for trend confirmation.
In a strong upward trending environment, the RSI rarely falls below 40, and will most always stick to the 50 – 80 range.
The corollary is true for a downtrend.
In this case the range will below the centreline and spike into the lower end of the indicator.
Overbought and oversold indications:
the standard settings for an overbought reading is 70 and for oversold it is 30.
this can be changed by the user to suit their own style.
I generally look for the RSI to register several extreme readings in a row before placing any great weight on the signals.
Centreline crossing:
When the RSI crosses the centreline it is a stronger signal that a trend change has happened than a simple extreme reading above or below the 70-30 lines.
When the indicator crosses the centreline to the upside, it means that the average gains are exceeding the average losses over the period.
The opposite is true for a downside cross.
When a centreline cross happens, it can be a good time to think about trade entry on a fresh pullback in price.
RSI trendline breaks:
RSI line itself can be interpreted by trendline analysis.
Its a simple trick but it is a useful analysis tool.
For example in an upward trending market,
Draw a line connecting the dips in the RSI line, if the RSI breaks this trendline to the downside it is an early indicator of an impending change.
A break of the RSI trendline often precedes a break of the price trendline on a price chart.
Relative strength index trading strategies.
Compound RSI Strategies:
A compound strategy is when you use two indicators together.
It is always advised to balance the signal of one indicator against another, this will help to cut out alot of false signals.
There are a few indicators that pair well with the RSI and using them together can proved better trading signals.
All of the above trading strategies should always be used with a risk management strategy alongside.
RSI, engulfing candlestick strategy:
In this trading strategy,
We combine the RSI indicator along with an engulfing candle stick.
This strategy will generate far less trades so you can afford to extend the stop loss position.
Only enter the market whenever the RSI gives an overbought or oversold signal which is supported by the a bullish or bearish engulfing candle.
Close the position on a solid break of the opposite RSI line.
The RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
The trader waits to get an engulfing candle to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the next days trade.
this signal led to a 550 point rise without triggering a 100 point stop loss.
that’s a 550 point gain in your account!
The RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
The trader waits to get an engulfing candle to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the next days trade.
this signal led to a 175 point rise without triggering a 100 point stop loss.
that’s a total gain of 725 points in your account in two trades!
that’s a solid performance by any ones standard.
In this trading strategy,
We combine the RSI indicator with the MACD.
First, enter the market whenever the RSI gives an overbought or oversold signal which is supported by a MACD signal line crossing.
And then close the position if either indicator provides an exit signal.
The RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
The trader waits for a signal line cross to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the next days trade.
this signal led to a 400 point gain without triggering a 50 point stop loss.
This combination indicator did not generate any further trades in the above time period.
RSI + MA Cross:
In this trading strategy,
We place a trade when the RSI gives an overbought or oversold signal which is supported by a crossover of the moving averages.
Close the position on an RSI divergence.
Although this trading system came close, it did not generate any signals over the 16 month time period!
I think we can count this one out as a useful trading system.
RSI Bollinger band:
In this trading strategy,
We combine the RSI indicator along with a Bollinger band squeeze.
First we wait for a Bollinger band squeeze to occur on a daily chart, the squeeze should come to within 150 points or so.
Only enter the market whenever the RSI gives an overbought or oversold failure swing.
which is supported by a tag of the bands in the same direction.
A bullish signal happens when the rsi falls below 30 and then rises above 30 again.
Then a daily candle touches the upper Bollinger band.
Close the position on an RSI divergence.
Again this trading system did not give any signal over the time period. We can count out this system also!
So there you have it!
Here are the results of the above back tests of the 5 trading systems;
Simple RSI strategy = In total this system made 220 point gain over 8 trades, 2 winning trades and 6 loosing trades. RSI, candlestick strategy = In total this system made 725 point gain over 2 trades, 2 winning trades and 0 loosing trades. RSI, MACD strategy = In total this system made 400 point gain over 1 trades, 1 winning trade and 0 loosing trades. RSI, MA Cross strategy = In total, this system made 0 trades and 0 points gained, RSI, Bollinger band strategy = In total, this system made 0 trades and 0 points gained,
It is plain to see that the best system in this back test is the RSI candlestick strategy. It did not give many trading signals but, when it did, They were fantastic signals.
And think about it;
The average hedge fund makes about 20% a year, with the very real risk of loosing a whole lot! and what does the average savings account return?
The winning strategy above made about 100% ( depending on the $/pip amount / or lot size ) on your initial capital while risking about 10 – 15% on each of the two trades.
That is some good food for thought!
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Author: E. Glynn.
I am a trend trader, I allocate 99% of my time to studying market action and 1% trading. I base all trading decisions on Elliott wave analysis, technical analysis, momentum indicators and sentiment readings.
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