Relative Momentum Index (RMI) – Rules, Strategy, Settings, Returns, Performance
Active traders, especially swing traders like to use oscillators to track the momentum of individual price swings to know when to get in at the beginning of an impulse swing — one oscillator that does a good job is the Relative Momentum Index (RMI). What do you know about the RMI?
The Relative Momentum Index (RMI) is a momentum-based oscillator that tracks the momentum of price swings to better spot overbought and oversold conditions in the market. It is similar to the Relative Strength Index (RSI), but rather than use the day-to-day differences in closing prices (gains and losses) to count the up and down days as in the RSI, the RMI counts the up and down days by comparing today’s close to n-days ago.
In this post, we will take a look at most of the questions you may have about the Relative Momentum Index: what it is, how it works, and how you can improve your trading strategies with it. Keep reading!
Key takeaways
- Definition: The Relative Momentum Index (RMI) is a momentum-based oscillator designed to identify overbought and oversold market conditions.
- Comparison to RSI:
- Similar to the Relative Strength Index (RSI) but differs in its calculation method.
- RMI compares today’s closing price to the closing price from n-days ago, rather than relying on day-to-day closing price differences.
- Key Concept:
- Incorporates momentum, measuring the rate of price changes over a specified period, into the RSI framework.
- Tracks both the magnitude and duration of price changes, providing a more robust measure of price momentum.
- Value Range:
- Oscillates between 0 and 100.
- Overbought: values above 70.
- Oversold: values below 30.
- Market Suitability:
- Effective in range-bound markets.
- Less reliable in strongly trending markets.
- We show you a complete Relative Momentum Index (RMI) trading strategy complete with trading rules.
- If you want to look at other indicators, please read our take on the best trading indicators.
What is the Relative Momentum Index (RMI)?
The Relative Momentum Index (RMI) is a momentum-based oscillator that tracks the momentum of price swings to better spot overbought and oversold conditions in the market. It is similar to the Relative Strength Index (RSI), but rather than use the day-to-day differences in closing prices (gains and losses) to count the up and down days as in the RSI, the RMI counts the up and down days by comparing today’s close to n-days ago.
In essence, the RMI is created by applying the concept of momentum, which measures the rate of change of prices over a specified period, to the RSI calculation. It uses a measure of momentum to count the up and down days instead of the day-to-day gains and losses used in the RSI. As a result, the RMI is both a measure of the magnitude and duration of price changes, which makes for a more robust tool for tracking the momentum price swings and spotting overbought/oversold conditions.
As with the RSI, its values range between 0 and 100, with values above 70 indicating an overbought market and values below 30 indicating an oversold market. While the oversold and overbought signals may work well in range-bound markets, they may perform poorly in strongly trending markets.
An example of what it might look like is shown below:
Relative Momentum Index (RMI) trading strategy – rules, backtest, returns, and performance
Let’s backtest a Relative Momentum Index (RMI) trading strategy that is complete with trading rules.
We make the following trading rules:
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We backtest all current and past stocks in the Nasdaq 100 index from 1995 until today. We allocate 20% to each trade, and thus, we can have a max of 5 positions at any time. Commissions and slippage are set to 0.03% for each trade (0.06% for a roundtrip).
We get the following equity curve:
Trading statistics and performance:
- Number of trades: 3479
- Average gain per trade: 0.8%
- Annual returns (CAGR): 18.5%
- Win rate: 69%
- Time spent in the market: 37%
- Risk-adjusted return: 49%
- Max drawdown: 22%
This is the code we used for the backtest (Amibroker):
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How does the RMI differ from the traditional RSI?
The RMI differs from the traditional RSI in that the former uses the change in closing prices relative to n-periods ago, which is a measure of price momentum, to count the up and down periods, whereas the latter uses the difference in closing prices between the current period and the period before it.
In the RMI, there are two period settings: the lookback period (n) for the momentum measure and the period for the length (N) of the index, which can be the same for both indicators. The n in the RSI is limited to 1, but it can be any value in the RMI. This is why the RSI compares the current closing price to that of the preceding period, whereas the RMI can compare the closing price of the current period to that of 5-periods ago.
In other words, if you set a 14-period RMI’s momentum length to 1, it will be the same as a 14-period RSI. The reason is that, with a setting of 1, the momentum parameter now measures only the period-to-period change in price. Increasing the momentum period setting (to 3 or 5, for example) makes the RMI indicator line smoother, which is why it is better than the RSI in identifying overbought/oversold conditions.
However, the RSI is better at showing divergences because it fluctuates more.
Who developed the Relative Momentum Index (RMI)?
The Relative Momentum Index (RMI) was developed by Roger Altman, an American investment banker. He introduced the indicator to the investing and trading public in the February 1993 issue of Technical Analysis of Stocks & Commodities magazine. Altman described the indicator as a variation of the Relative Strength Index (RSI) that aims to improve the signal provided by the traditional RSI indicator when the price reaches oversold/overbought areas. Here’s how he described it:
“The RSI is modified by counting up and down days starting from today’s close relative to the close Y days ago, where Y is not necessarily 1 as required by the RSI. The RSI is released from the arbitrary restriction of comparing consecutive days for price changes” changing the period to 20 days, but with Y set at 5 instead of 1 makes it “easier to anticipate tradable reversal points compared with the one-parameter RSI.
This modification is called the relative momentum index (RMI), in which momentum is substituted for strength because a momentum index is usually obtained by creating a moving average of the most recent closing price compared with the close Y days in the past.”
What is the formula for the Relative Momentum Index?
The formula for the Relative Momentum Index is the same as that of the RSI, except that momentum up and momentum down are used rather than Up Period and Down Period. It is given as follows:
But we have to get the RM (relative momentum) first. The formula for RM is given as follows:
RM = Average MomUp/Average MomDown
Where:
MomUp = Current Close — Close n-periods ago
MomDown = Close n-periods ago — Current Close
Average MomUp = SMMA(MomUp, N)
Average MomDown = SMMA(MomDown, N)
Thus, the RM can be written as:
RM = SMMA(MomUp, N)/SMMA(MomDown, N)
Where:
- MomUp = any period with a positive price change relative to n-periods ago
- MomDown = any period with a negative price change relative to n-periods ago
- n = the number of periods for measuring the momentum
- N = the period length of the indicator
- SMMA = smoothed moving average. EMA can also be used in place of SMMA.
How is the RMI calculated?
The RMI is calculated using the following steps:
- Calculate the price changes during the MomUp (positive momentum) and MomDown (negative momentum) periods by comparing the closing prices with those of n-periods ago and recording the absolute values.
- Calculate the average price changes for the MomUp and MomDown periods within the N-period length of the indicator using the smoothed moving average or EMA method.
- Find the ratio of the average MomUp price change to the average MomDown price change by dividing the former by the latter — this ratio is the relative momentum.
- Convert the relative momentum to the relative momentum index (RMI) with a value range between 0 and 100 by bringing in the factor of 100 using this formula: RMI = 100 x RM / (1 + RM)
How do you interpret the RMI values?
To interpret the RMI values, you have to consider where the value falls within the indicator’s range of 0 to 100. Values below 30 suggest that the market is oversold. When the values rise above 30, it indicates an emerging upswing — above 50 implies that the upswing is gaining momentum until the value crosses the 70 mark.
Above the 70 mark, the market is considered overbought. When the values decline below the 70 mark, it suggests an emerging downswing. Declining values imply increasing downward momentum until the 30 mark is crossed, which suggests an oversold market.
What is considered an overbought level in the RMI?
A value above the 70 mark is considered an overbought level in the RMI. It is believed that when the indicator is in this area, the market has become extended in the upward direction and may be ready to experience a pullback as traders in the upswing may start taking profits.
When that happens, the indicator will start falling from the overbought level. However, note that, in a strong uptrend, the indicator can stay in the overbought zone without falling below the 70 level for a long time.
What is considered an oversold level in the RMI?
A value below the 30 mark is considered an oversold level in the RMI. Traders believe that when the indicator is in this area, the market has become extended in the downward direction and may be ready to rally as traders in the downswing may start booking profits and covering their shorts.
When the rally starts, the indicator will begin to rise from the oversold level. However, note that, in a strong downtrend, the indicator can stay in the oversold zone without rising above the 30 level for a long time.
How does the RMI help identify trends?
The RMI helps identify trends via the direction it is moving. The indicator’s direction usually synchronizes with that of the price swings. So, when the indicator is moving upward, it suggests that the price is moving in the upward direction, and when the indicator is moving downward, it means that the price is moving in the downward direction.
However, the RMI only identifies short-term trends or price swings, not the main trend — the main trend may be upward while the indicator is moving downward during a pullback.
What are the main uses of the RMI in trading?
The main uses of the RMI in trading include:
- Tracking the momentum of individual price swings — this is helpful to know when a pullback in a trending market is exhausted and when a price swing is about to reverse to the opposite swing in a ranging market
- Spotting an overbought and oversold market condition — this can help in booking early profits
- Anticipating potential market reversals — traders can use the divergence signals to anticipate price reversals, especially in a range-bound market
Can the RMI be used for all asset classes?
Yes, the RMI can be used for all asset classes since it is calculated using only the price data and all asset classes display their valid price data. This is unlike volume-based indicators that cannot be used in certain markets, such as the spot forex market which does not have a central exchange and, as such, does not have reliable volume data.
Given that the RMI uses only the price data, it can be used in all assets, including forex, cryptos, stocks, bonds, and commodities.
How does the RMI perform in different market conditions?
The RMI performs differently in different market conditions. In a range-bound market, the indicator tracks the price swings, often showing overbought signals when the price is around the upper boundary of the range and oversold signals when the price is around the lower border of the range.
However, in a strongly trending market, the indicator may stay in the upper region or even in the overbought region and rarely move to the oversold region if it is an uptrend. The opposite is true for a strong downtrend.
What is the default period for the RMI?
The default period for the RMI will depend on the trading platform. In TradingView, for instance, the default period is 3 for the momentum length and 14 for the indicator length.
The setting may be different for other trading platforms. Whatever, the setting in your own trading platform, you can always adjust it to what you want.
How can you adjust the RMI settings?
To adjust the RMI settings, you click on the indicator’s setting button and a box will pop up where you input your preferred settings. The best way to know the right settings to use is to backtest your strategy, experimenting with different settings to know the ones that offer the best performance.
Also, when trading, you document your results and periodically evaluate your results to know when you need to adjust the settings again.
What is the difference between the RMI and other momentum indicators?
The difference between the RMI and other momentum indicators is that the RMI offers a smoother indicator line than most other momentum indicators, which fluctuate a lot.
The reason for this is that the RMI uses the price change relative to n-periods ago rather than the period-to-period price change. This way, recent price fluctuations won’t affect the smoothness of the indicator line that much.
How does the RMI compare to the MACD?
The RMI compares favorably to the MACD if the aim is to use it to track the movement of short-term price swings rather than medium-term or long-term trends. While the MACD uses moving average crossovers to track the trend and the gap between the moving averages to estimate the momentum of the trend, the RMI uses the direct momentum measure to calculate and track the momentum of individual price swings.
Can the RMI be combined with other indicators?
Yes, the RMI can be combined with other indicators to improve its signals. The best indicators to combine with the RMI are moving averages and volume indicators. You can use the moving average to track the main trend, while you use the RMI overbought and oversold signals to find entry and exit points during a pullback.
In an uptrend, you for long entries only in oversold conditions, and in a downtrend, you look for sell setups only at the overbought conditions. Volume indicators can also help to confirm your entry signals, especially if you are trading breakouts.
How can traders use the RMI to improve entry points?
Traders can use the RMI to improve entry points by looking for long entries only when the market is in an oversold condition and short entries only when the market is shown to be in an overbought condition.
This can be very helpful in a range-bound market where you aim to long from the lower border and short from the upper border of the range. In a trending market, you only look for buy setups and only when a pullback has shown oversold condition. For a downtrend, you look for only sell setups at overbought conditions.
How does the RMI help with exit strategies?
The RMI helps with exit strategies by showing overbought and oversold conditions. If you are long, you may want to take profit or at least lock in some profits when the RMI shows an overbought signal.
Likewise, if you are short, you may want to cover your short or at least lock in some profits when the indicator shows an oversold signal.
What are common strategies for using the RMI?
The common strategies for using the RMI include:
- Mean-reversion strategies: These strategies aim to trade the reversal of the price to its mean. They work better in a range-bound market and can be executed with the RMI overbought and oversold signals, as well as the divergence signals.
- Trend-continuation swing trades: With these kinds of trades, the aim is to trade the beginning of a new impulse wave in the direction of the trend after a pullback. The RMI overbought and oversold signals can tell you when a pullback is exhausted.
Can the RMI be used in both trending and ranging markets?
Yes, the RMI can be used in both trending and ranging markets. In a trending market, you use it to look for trades in the direction of the trend — buy setups at oversold conditions in an uptrend and sell setups in overbought areas in a downtrend.
When using the indicator in a ranging market, you can trade both the overbought and oversold signals — the overbought signal at the upper border of the range and the oversold signal at the lower border of the range.
What are the limitations of the Relative Momentum Index?
The limitations of the Relative Momentum Index include:
- It cannot show you the direction of the long-term trend on your trading timeframe
- It can be lagging
- It can still give false signals
How can beginners start using the RMI?
Beginners can start using the RMI by opening a demo account and practicing with the indicator until they understand how it works. Then, they can formulate strategies with it and backtest them to find the ones with an edge in the market they want to trade.
What are common mistakes traders make with the RMI?
The common mistakes traders make with the RMI include:
- Trading without having a reliable strategy with clear entry and exit points
- Not backtesting their strategies before using them to trade
- Trading without a risk management plan
Where can you find the Relative Momentum Index on trading platforms?
You can find the Relative Momentum Index in the indicator section of trading platforms. Simply search for the indicator and you will find it if it is preinstalled in your trading platform. If it is not, you will have to get a custom version for your platform and install it first before you can use it on the platform.