RSI 14 Debunked – Do This Instead (Statistics, Numbers, Facts)

The Relative Strength Indicator, abbreviated RSI, is probably the most popular trading indicator. It’s mentioned in almost endless posts and articles on the internet. To our knowledge, the standard default setting of 14 days is mostly used. 

But does the default setting of 14 days work? Can we debunk this setting as faulty? 

Let’s find out by backtesting to get facts and statistics

What is RSI 14?

RSI 14 is when you use a 14-day lookback period to calculate the RSI value. This means that today’s RSI value is based on the last 14 days’ RSI, including today. 

What is the default RSI value or settings?

The default value setting for RSI is 14 days. Welles Wilder (1935-2021) mentioned this in his book New Concepts in Technical Trading Systems, published in 1978, where he invented the RSI indicator.

Why is RSI 14 default?

We believe Wilder made an arbitrary number, which the trading community has since “accepted”.

Moreover, when Welles Wilder wrote the book, the markets were different than today. For example, in 1982, futures trading for S&P 500 started, which has undoubtedly changed the behavior of the markets. 

Facts and statistics about the 14-day RSI

There is only one way to determine how the 14-day RSI performs: to backtest to determine the statistics and facts. 

For this exercise, we use Amibroker’s optimization feature to determine how the settings perform. We make the following trading rules:

  • We buy when the 14-day RSI drops below 45, 40, 35, 30, or 25; and
  • We sell when the 14-day RSI ends above 55, 60, 65, 70, or 75.

When we run the backtest, we get the following table for S&P 500 when we rank the results on annual returns (CAR):

The best strategy is to buy when the 14-day RSI breaks below 45 and sell when it reaches 75. These settings generated 30 trades from 1993 until today, returning 8.51% annually. For comparison, buy and hold returned 10.1%, including reinvested dividends.

If we invested 100,000 in 1993 and traded this strategy until today, the equity would have grown like this compared to buy and hold S&P 500:

RSI 14 debunked
RSI 14 debunked

Evidently, the best 14-day RSI strategy follows a buy-and-hold strategy but ultimately underperforms (the blue line is buy-and-hold, while the black line is RSI 14). 

For example, the max drawdown for buy and hold is 55%, while the 45/75 RSI strategy had the same max drawdown. 

What’s the point of trading such a strategy if you underperform and have the same drawdown? There is not much to gain. 

What if we backtest to gather statistics about other assets?

We backtested gold, bonds, and commodities, and the results are even worse: they fail to beat buy-and-hold, and the assets have the same or worse drawdowns. As a matter of fact and evidence, the RSI indicator doesn’t work for gold and commodities, while it partially works for bonds. 

Bummer. 

RSI 14 debunked – do this instead

It’s difficult to find a strategy that beats buy-and-hold. Instead, we prefer to look for trading strategies with good adjusted returns. 

How do you evaluate risk-adjusted returns? You need to study several performance statistics of the strategy.

One good risk metric we like is dividing the annual return by the time invested in the market:

For example, if you manage an 8% annual return and only spend 10% of the time invested, the risk-adjusted return is 80% (8 divided by 0.1).

Moreover, another helpful risk metric is max drawdown.

Let’s backtest premium trading strategy #5 to show you what we believe is better than the standard setting of 14 days as the lookback period. If we backtest strategy #5 on S&P 500, we get an equity curve like this:

RSI 14 debunked do this instead
RSI 14 debunked do this instead

The strategy underperforms, but the ride is a lot smoother, as you can see by the red line, meaning you suffer less pain from temporary losses along the way. The annual return is 7.7%, but you are invested only 15% of the time; thus, the risk-adjusted return is 51%. The max drawdown is 21%. When you’re not invested, you can employ your capital in complementary trading strategies

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