Range Expansion Index (REI) – Strategy, Rules, Results

In the fast-paced world of financial markets, traders are always seeking new indicators to perform better technical analysis and improve their trading game — one such indicator is the Range Expansion Index (REI). What do you know about this indicator?

The Range Expansion Index is an arithmetically calculated technical indicator that shows the momentum of price action by comparing the true high and low prices over a specified lookback period. It is a momentum oscillator that moves between −100 to +100 and indicates overbought and oversold price conditions when the indicator goes beyond the +60 and -60 levels.

In this post, we will take a look at the details of the Range Expansion Index (REI): what it means and how to calculate it, interpret it, and use it in trading. Keep reading!

Key takeaways

• The Range Expansion Index is an arithmetically calculated technical indicator that shows the momentum of price action by comparing the true high and low prices over a specified lookback period.
• The range expansion index does not directly help in identifying market trends; rather, it can help show the relative strength or weakness of the price action in the direction of the trend.
• We show you a Range Expansion Index (REI) trading strategy complete with trading rules.

What is the Range Expansion Index (REI) in trading?

In trading, the Range Expansion Index is an arithmetically calculated technical indicator that shows the momentum of price action by comparing the true high and low prices over a specified lookback period. It is a momentum oscillator that moves between −100 to +100 and indicates overbought and oversold price conditions when the indicator goes beyond the +60 and -60 levels.

The indicator was developed by Thomas DeMark and published in his 1994 book: The New Science of Technical Analysis. Arithmetically calculated, the REI is designed to overcome the issues seen in exponentially calculated oscillators, like MACD, which put much weight on recent data and thus have large fluctuations.

While the indicator shows overbought and oversold conditions, DeMark recommends duration analysis and advises against trading in extreme overbought or oversold conditions that have six or more bars in the overbought/oversold regions.

What does the Range Expansion Index look like on a chart? Below is an example of the REI indicator (the lower pane):

Key Data and Insights on the Range Expansion Index (REI)

The Range Expansion Index (REI) is a momentum oscillator developed by Thomas DeMark. It measures the strength of price movements and ranges from -100 to +100. When the REI exceeds +60, the market is considered overbought, and when it falls below -60, it is oversold.

Table of Key Statistics (Range Expansion Index)

Statistic/Key Data	Value/Description
Indicator Type	Momentum Oscillator
Calculation Range	−100 to +100
Overbought Level	Above +60
Oversold Level	Below -60
Best Setting for Day Trading	Depends on strategy and backtesting results
Example Holding Period (QQQ)	7 trading days
Average Gain per Trade (7 days)	0.99%
Win Rate	62%
Average Gain (Winning Trades)	3.4%
Average Loss (Losing Trades)	3.1%
Max Drawdown	49%
Trading Asset Used in Example	Nasdaq ETF (QQQ)
Developed by	Thomas DeMark
Recommended Combinations	With trend indicators like Moving Averages
Historical Performance	Reasonably effective when part of a robust strategy

Overview and Performance – Range Expansion Index (REI)

The REI is particularly useful for identifying potential entry and exit points in trading. For example, when applied to the Nasdaq ETF (QQQ) with a 7-day holding period, the REI demonstrated an average gain of 0.99% per trade and a win rate of 62%. The strategy showed an average gain of 3.4% on winning trades and an average loss of 3.1% on losing trades, though it experienced a maximum drawdown of 49%. The REI’s effectiveness improves when used alongside trend indicators such as moving averages.

How does the Range Expansion Index help in identifying market trends?

The range expansion index does not directly help in identifying market trends; rather, it can help show the relative strength or weakness of the price action in the direction of the trend. Thus, if there is an established trend, the REI helps you to participate in the trend by showing when the momentum is in the direction of the trend.

Measuring the velocity and magnitude of directional price movements, the REI shows overbought/oversold price conditions. It does this by calculating the relation between the sum of “strong” price changes and all price changes for the period.

What are the key indicators of REI for trading?

The key indicators of REI for trading are overbought/oversold levels and the duration analysis.

• Overbought/oversold levels: As with many other momentum oscillators, the REI’s overbought/oversold levels are meant to indicate when the market is unstable and likely to reverse. But the REI simply crossing overbought or oversold levels doesn’t mean the price will reverse. You should wait for the indicator to return to neutral and then go back to the oversold or overbought region before expecting a price reversal.
• Duration analysis: This refers to the time the REI spends in the overbought or oversold region. If it is six or fewer price bars, it is considered mild. For example, if REI got to 100 for four consecutive days, it is still a mild overbought reading. But if it remains overbought or oversold for more than six price bars, it is likely a strong trend is in play.

Range Expansion Index (REI) trading strategy – rules, backtest, returns, and performance

Let’s backtest an REI trading strategy complete with trading rules.

We make the following trading rules:

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There is only one condition/trading rule for when to buy and one for when to sell. It can’t get any simpler than that!

We backtest the trading rules on Nasdaq and use the ETF with the ticker code QQQ.

First, let’s backtest the results and the holding time. We own QQQ for 1-10 trading days:

The second column shows the average gains for holding N trading days. For example, if we hold for 7 trading days, we get on on average 0.99% per trade. This is many times more than any random period of similar length. The last column shows the Profit Factor, which is a popular trading performance metric.

Let’s look at the equity curve if we sell after 7 trading days:

From inception until today, there have been 348 trades, and the average gain per trade is 0.99%. The average gain is high, and the win rate is moderate at 62%, considering this is a mean reversion strategy. The average winner is 3.4%, and the average loser is 3.1%. The max drawdown is, sadly, a bit high at 49%, which happened during the bear market of 2000-03.

All in all, these simple rules seem to work reasonably well.

Does the strategy work on other assets?

No, it doesn’t work well on the bonds (TLT) or gold (GLD). However, that doesn’t mean the strategy is curve-fitted. All assets move differently!

This is the complete Amibroker code for the strategy:

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How to calculate the Range Expansion Index in trading software?

To calculate the range expansion index in trading software, the indicator makes use of a very complex formula that is based on different conditions. After all the conditions are met, the final calculation of REI uses this formula:

REI = SUM(VALUE, N) / SUM(ABSVALUE, N)

The good thing is that you don’t need to do the calculation yourself since the trading platform will do it for you. All you have to do is simply place the indicator on your chart and input the settings you want. The default setting is 8 periods, but you can set what you want.

Can the Range Expansion Index predict market reversals accurately?

Yes, the range expansion index can predict market reversals accurately, but as with all indicators, it cannot be accurate all the time. Sometimes, its prediction would be correct, but other times, it wouldn’t.

Generally, when the indicator crosses beyond the +60 or -60 levels mildly, it means the market is overbought or oversold, signaling a potential reversal. But the REI simply crossing overbought or oversold levels doesn’t mean the price will reverse. It must not stay there for more than 6 price bars, and better still, it should return to neutral and then go back to the oversold or overbought levels again before expecting a price reversal.

What is the best REI setting for day trading?

The best REI setting for day trading depends on your strategy, trading timeframe, and ultimately, your backtesting result. Your strategy would determine the periods you set for the REI. It also determines the timeframe you do your analysis and trading on.

And your timeframe would also affect the settings you choose for the REI. But ultimately, how you know the best REI setting for day trading is backtesting your strategy with different settings to know the one that offers the best performance.

How does REI differ from RSI in technical analysis?

The REI differs from the RSI in that it has a time-based analysis for its overbought and oversold levels. With RSI, the more extreme the indicator, the more likely there will be a reversal. But that is not the case with the REI.

An important component of the REI overbought/oversold analysis is the time the indicator spends in the overbought/oversold region without returning to the neutral level. The longer it spends there (anything beyond six price bars), the more likely the trend is very strong and not ready to reverse soon.

What time frames work best with the Range Expansion Index?

The time frames that work best with the range expansion index would depend on the trading style and strategy. A swing trader may have to do their analysis on the daily or 4-hourly time frame, while a day trader would have to use a lower time frame like the hourly, 30-minute, or 15-minute time frame.

A position trader may even have to go higher than the daily time frame. However, for any given trading style and strategy, the only way to know the best time frame is to backtest the strategy on different relevant time frames to know where it performs best.

How to interpret high and low REI values?

To interpret high and low REI values, you have to understand that it oscillates between −100 and +100 and indicates overbought and oversold price conditions when the indicator goes beyond the +60 and -60 levels.

Generally, when the REI values are above +60, the market is considered overbought and likely to reverse to the downside. Likewise, when REI values are below -60, the market is considered oversold and likely to reverse to the upside.

But the REI simply crossing above +60 or below -60 doesn’t mean the price will reverse. You should wait for the indicator to return to neutral and then go back to the oversold or overbought region before expecting a price reversal. Also, the duration in the overbought/oversold region matters — if the indicator stays there for more than six price bars, the trend is likely too strong and unlikely to reverse soon.

What does a rising Range Expansion Index indicate in a bear market?

In a bear market, a rising range expansion index indicates a potential reversal to the upside so traders can look for buying opportunities. This is especially true if the indicator had fallen below the -60 level before rising. It is also important that it does not stay below the -60 level for more than six price bars before rising to neutral anytime it falls into the oversold region.

How can the Range Expansion Index be combined with other indicators?

Yes, the range expansion index can be combined with other indicators to get a better understanding of the phase of the market cycle and price movement. In fact, Tom Demark, the creator of the indicator, recommends combining it with other indicators to get the best out of it.

The REI is best combined with indicators that show the direction of the main trend. An example is a moving average indicator. When combining the REI with a moving average (MA), you can use the MA to find the trend direction and use the REI to anticipate the end of a pullback so that you trade the next impulse wave in the trend direction. The overbought and oversold signals can be very helpful in a downtrend and uptrend respectively.

Can REI be used for both forex and stocks?

Yes, REI can be used for both forex and stocks. The indicator is calculated from price data alone, so it can be used in any market, unlike volume-based indicators, which are not suitable for the spot forex market where there is no central exchange and therefore, no reliable volume data. Whether you are trading stocks or spot forex, you can use the REI if your trading platform supports it.

What are common mistakes when using the Range Expansion Index?

The common mistakes when using the range expansion index include:

• Relying solely on the indicator: The REI is meant to be combined with other indicators to formulate a reliable trading strategy.
• Thinking that more extreme values mean a higher likelihood of a reversal: More extreme values do not indicate any higher potential for a reversal.
• The longer in overbought/oversold regions means higher chances of a reversal: If the indicator stays in the overbought/oversold region for more than six price bars, the trend is probably very strong and unlikely to reverse.

How do REI signals integrate with candlestick patterns?

REI signals can be integrated with candlestick patterns to create a robust trading strategy. To do this, you must understand some specific candlestick patterns that you want to trade with and also understand how the REI works so you can harmonize both.

For instance, you can choose to work with only two reversal candlestick patterns — say, engulfing patterns and pin bars. So, when the price is in an uptrend and a pullback occurs, you watch for oversold levels in the REI and any of the two reversal candle patterns. If the indicator is in the oversold region and a hammer or bullish engulfing pattern appears on the chart, that will be a buy signal.

What is the historical effectiveness of REI in market prediction?

The historical effectiveness of REI in market prediction depends on the timeframe you look at. Generally, the indicator has performed reasonably well when used as a part of a robust strategy that includes trend direction and time in the market. However, the performance of using the indicator alone has been abysmal.

How to adjust REI parameters for volatile markets?

To adjust REI parameters for volatile markets, you have to have a way to predict when the market will be volatile so you can adjust the settings of the indicator. In this case, you can use the ATR indicator or the choppiness index.

For markets that are already known to be volatile, you can adjust the indicator’s settings if you must trade them. Rather than the default 8-period setting, you can experiment with 12, 14, or 16 periods to see which one offers the best performance.

What educational resources are best for learning the Range Expansion Index?

The best education resources for learning the range expansion index are the ones offered by Tom Demark himself. Here are some of the common ones:

• Demark’s books: These include The New Science of Technical Analysis by Thomas DeMark; New Market Timing Techniques by Thomas DeMark; and DeMark On Day Trading Options by Thomas DeMark and Thomas DeMark, Jr.
• Demark’s websites: https://demarkhelp.zendesk.com/hc/en-us/categories/360003606693-Education-and-Training

How does leverage affect REI-based strategies?

Leverage does affect REI-based strategies, just as it affects other strategies and indicators. Traders use leverage to increase the size of their potential profits when trading. However, leverage is a double-edged sword. The same way it magnifies potential profits, it can also magnify potential losses, leading to a trader losing all the invested capital and potentially more — if the broker doesn’t offer negative balance protection.

For instance, if a trader is using a 10x leverage to make a long trade and the market loses 1% of its value, the trader would lose 10% of trading capital plus spreads. If the market declines by 10%, the trader would be wiped out.

Are there automated trading systems that use the Range Expansion Index?

Yes, there are automated systems that use the range expansion index, but they don’t use the REI alone as a strategy on its own. Rather, they use the REI as a part of the trading strategies that have been backtested and forward-tested to confirm the profitability. The good thing about automated systems is that they are easy to backtest and optimize for robustness and profitability.

What are the limitations of using REI in technical analysis?

The limitations of using the REI in technical analysis are plenty. These are some of them:

• It does not reliably show the direction of the main trend.
• The indicator is not like any other momentum oscillator that indicates overbought/oversold level where more extreme values indicate a higher likelihood of a reversal. Its special interpretation has to be followed.
• It can be confusing to use, as the longer the indicator is in the overbought/oversold region, the lower the likelihood of a reversal.
• It does not give buy or sell signals, as it cannot be used alone.

How to use the Range Expansion Index for risk management?

The range expansion index cannot be directly used for risk management, as it does not tell you where to place your stop-loss orders or how much position size to use in a trade.

However, you can combine it with other analysis tools to create a robust trading strategy with clear risk management parameters, such as your stop-loss size or level, your position sizing, and what percentage of your account to risk per trade.

Can REI be the sole basis for a trading strategy?

No, the REI cannot be the sole basis for a trading strategy, as it cannot reliably identify the main trend direction or provide reliable buy and sell signals. It can only be used as a part of a trading system that consists of other analysis tools.

In fact, its creator recommends combining it with other indicators, especially trend-identifying indicators like the moving average. With that, you know when a trend is formed and then use the REI to find trading opportunities in the direction of the trend.

What are the psychological factors affecting REI readings?

There are no psychological factors affecting REI readings per se, but the trader interpreting and analyzing the readings may be affected by various psychological factors, such as greed, fear, hope, anger, and undue expectations, so much so that they misinterpret the indicator’s signals and start trading their feelings.

How to backtest a trading strategy using the Range Expansion Index?

To backtest a trading strategy using the range expansion index, you have to follow these steps:

1. Study the indicator to know how it works
2. Identify and study the markets you want to trade
3. Use the REI together with other indicators to formulate a trading strategy with clear entry and exit criteria and risk management parameters
4. Write the code to convert the strategy to a trading algorithm
5. Run your backtesting and document the result
6. Analyze the results of your backtesting

What recent advancements have been made in REI analysis?

The recent advancements that have been made in REI analysis include the following:

1. Using the TD POQ (Price Oscillator Qualifier) to validate the REI signals

For a buy signal, the following conditions must be met:

• The REI has been in the oversold condition for less than six bars.
• The last complete bar closes below the previous bar.
• The current bar’s open must be lower than or the same as the highs of the previous two bars.
• The market must be trading higher than the open price and has broken above the high of the last two days.

For a sell signal, the following conditions must be met:

• The REI has been in the overbought condition for less than six bars.
• The last complete bar closes above the previous bar.
• The current bar’s open must be higher than or the same as the lows of the previous two bars.
• The market must be trading lower than the open price and has broken below the low of the last two days.

2. Reducing the overbought/oversold levels

Some traders have reduced the levels that indicate overbought and oversold levels to +40 and -40 respectively. They did this because they believe that recent market conditions don’t allow the indicator to reach the original +60 and -60 levels.