Last Updated on August 25, 2022 by Oddmund Groette
Traders always want to have a Holy Grail trading strategy or indicator that can allow them to make all the money in the shortest possible time. While such indicators do not exist, the Big Three are among the best indicators for short-term trading. What are they?
The Big Three trading strategy includes RSI, ADX, and IBS. These technical indicators are very good for short-term mean-reversion or trend-following strategies. While the RSI and IBS are very good for mean-reversion trading, the ADX is a quality indicator for trend-following strategies.
Let’s take a look at these indicators.
What is the Big Three Trading Strategy?
The Big Three trading strategy refers to any strategy that is based on these three — RSI, IBS, and ADX — which are among the best indicators for short-term trading. These technical indicators are very good for mean-reversion or trend-following strategies. For example, short-period RSI and IBS are very good for mean-reversion trading strategies because they can show price momentum and overbought/oversold conditions in the market
On the other hand, the ADX is a quality indicator for trend-following strategies. The indicator can be used to identify when the market is trending in one direction, even though it does not indicate the direction of the trend, and it can also show the strength of the trend.
Backtesting results show that these three indicators perform well for short-term trading, which is why we call them the Big Three. They are popular indicators that are available on most trading platforms. You can use them to create and optimize trading strategies that you can easily convert to trading algos.
What is the RSI indicator?
The relative strength index (RSI) is a momentum indicator used in technical analysis. It shows the speed and magnitude of a security’s movement by measuring both gains and losses over a given period. RSI was developed by Welles Wilder who first introduced it in June 1978 in a magazine called Commodities (now Futures).
The value of RSI oscillates between 0 and 100, so it can be a maximum of 100, and a minimum of 0. But it rarely gets to those extremes. Generally, values above 70 suggest an overbought market condition, while values below 30 suggest an oversold market condition.
RSI also gives the divergence signal. A bullish divergence occurs when the price sets a new low, while the RSI doesn’t or vice versa. It is considered a buy signal. A bearish divergence occurs when the price sets a new high, while the RSI doesn’t or vice versa. It is considered a sell signal.
Backtesting results indicate that shorter timeframes work best for the RSI when trading stocks. In fact, the best results were gotten with RSI periods of two and three days. But don’t take our words for it. You have to formulate your own strategy and backtest to know the period that works best for the security you want to trade.
What is the ADX indicator?
ADX stands for Average Directional Movement Index, which is a component of the Directional Movement System developed by Welles J. Wilder and introduced in 1978. This system attempts to measure the strength of the price trend in positive and negative directions using the DMI+ and DMI- indicators along with the ADX.
The system consists of three components:
- The Plus Direction Indicator (DMI+): rising values indicate that the uptrend is gaining momentum
- The Minus Direction Indicator (DMI-): rising values indicate that the downtrend is gaining momentum
- The ADX: measures the strength of the trend based on the two above
The ADX is considered a “non-directional” indicator. It was designed to help traders identify trending markets and determine trend strength but not the direction of the trend. The indicator is based on comparing the highs and lows of price bars and does not use the close of the bar.
Backtesting results show that a short period of about 5-10 days works best, and the best threshold value for a strong trend is around 30-40, rather than the 25 popularly used.
What is the IBS indicator?
The Internal Bar Strength indicator (IBS) measures the relative position of the closing price relative to the High and Low. It is a mean-reversion indicator that helps you buy on weakness and sell on strength. The indicator oscillates between 0 and 1. As a mean-reversion indicator, a low value is a bullish signal, while a high value is a bearish signal.
The backtesting result of a simple IBS strategy where the asset is bought on price close if IBS is lower than 0.2 and sold any day later when the IBS closes above 0.8, showed reasonable performance, with a profit factor of 1.92.
Big Three trading strategy (backtest and example)
A backtest of the Big Three trading strategy is coming soon.