RSI of Volatility Indicator

It’s common knowledge by now that low volatility is conducive to bullish behavior and high volatility is conducive to bearish behavior. To create a trading system that would short bursts of high volatility and buy short periods of low volatility I took the 5-day RSI of the daily Close-Open Range.

Edit: Commenter Ramiro called to my attention that I do not actually take the RSI of the Close-Open range, just the Close-Open. I’m actually measuring the magnitude AND the direction, meaning that this is just simply another mean-reversion indicator, NOT a volatility indicator.

To turn my indicator into a trading system, I optimized buy and sell threshold (1-100) on SPY from 1/1/2000 – 12/29/2012. I optimized a long-only version of the system. Here is a picture of the 3D optimization with CAGR on the z-axis.

RSI 5-Day Extreme Close Range Optimization Buy Thresh 1-1-2000 - 12-29-2012

Buy Threshold

RSI 5-Day Extreme Close Range Optimization Sell Thresh 1-1-2000 - 12-29-2012

Sell Threshold

There is a small hilly region near the middle. I chose 40 as my buy threshold and 55 as my sell threshold since they are round numbers within the hilly region.

One thing peculiar that I noticed, but can’t seem to explain is that there are two of every set of system statistics, and the only difference is 1) the parameters of buy/sell threshold are switched and 2) the number of trades:

RSI 5-Day Extreme Close Range Optimization Peculiar 1-1-2000 - 12-29-2012

After some pondering I noticed that it might be because some of the buying is negligible. For example, if we have a 40/60 threshold then we will buy if the RSI is at 30, regardless if the 40 or the 60 is the buy threshold. However, the problem that I came across is that if the RSI is at 30 today, but is at 50 tomorrow, then we will buy & hold for a 40/60 threshold (buy when RSI < 40 and sell when RSI > 60), but we will buy & sell for a 60/40 threshold ( buy when RSI < 60 and sell when RSI > 40). I can’t seem to figure out why there each set of system statistics has a twin.

Next, I optimized the short and cover threshold (1-100) on the same data, using a short-only version of the system. Here is a picture of the 3D optimization with CAGR on the z-axis.

RSI 5-Day Extreme Close Range Optimization Short Thresh 1-1-2000 - 12-29-2012

Short Threshold

RSI 5-Day Extreme Close Range Optimization Cover Thresh 1-1-2000 - 12-29-2012

Cover Threshold

There is another small hilly region near the middle. I chose 55 as my short threshold and 40 as my cover threshold since they are round numbers within the hilly region.

The peculiarity of the long only side of the system does not seem to exist on the short side.

Here is the optimized equity curve with a system of the following rules:

  • Buy RSI < 40
  • Sell RSI > 55
  • Cover RSI < 40
  • Short RSI > 55

RSI 5-Day Extreme Close Range Optimization Equity Curve 1-1-2000 - 12-29-2012

The equity curve looks similar to that of many mean-reversion trading systems.

To check for robustness, I tested this system on multiple ETFs from 1/1/2000 – 12/29/2012.

RSI 5-Day Extreme Close Range ETF Scan 1-1-2000 - 12-29-2012

For further robustness, I tested this system using different lengths of RSI on SPY.

RSI 5-Day Extreme Close Range Length Optimization 1-1-2000 - 12-29-2012

One of my concerns is the success of the system since 2010, since many systems seemed to have performed differently or even completely stopped working from around that period. Here is the performance of the system on multiple markets from 1/1/2010 – 12/29/2012

RSI 5-Day Extreme Close Range ETF Scan 1-1-2010 - 12-29-2012

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7 comments

  1. Nice work. Could be the optimization result weirdness is due to how you have your trade delays set, or you may need to have your buy code look like this:
    Buy = ref(RSI>40,-1) and RSI<40;
    Sell = ref(RSI60;

    I could be wrong, but without the correct code the system may be trying to buy and sell all on the same bar, which would give you the 2000+ trades.

  2. Hi,

    Thanks for all the good ideas and also for this one. Like your blog very much.

    I did not succeed while trying to replicate your results. Can you please explain a bit more what you are actually doing. I calculated RSI(abs(Cl(SPY) – Op(SPY)), 5) and used your thresholds for long and short entries and exist but my equity curve is down sloping…

    Regards,
    Ramiro

    1. Thank you for your interest.

      I made a mistake when I stated that I used 5-day RSI of the Close-Open range; I actually just used the 5-day RSI of the Close-Open. The code would be RSI(Cl(SPY)-Op(SPY),5).

      Best,
      Bing

  3. Selling options (puts _and_ calls) during periods with strong bursts of volatility is a strategy many option traders use to profit. Volatility is mean reverting, so as long as you can hold onto the shorts for a little, you have a good chance of profiting.

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