Last Updated on January 15, 2023
The financial market moves in waves — it rises and falls — which is why you hear slogans like “Buy the dip” and “Sell the rip.” Today, we will focus on the “Sell the rip” strategy. What does it mean?
Sell the rip refers to a trading strategy that aims to sell an asset (either closing an open long position or opening a short position) when its price has risen to a level considered overvalued. This investment approach follows the basic principle of “buy low, sell high,” but in this case, the focus is on the selling aspect.
The sell the rip strategy is based on the idea that an asset can get overvalued and overpriced, which makes it rip for price correction or even a market crash.
In this post, we take a look at the sell the rip strategy and how to use it to your benefit. At the end of the article, we provide you with a sell the rip strategy backtest.
What does it mean to sell the rip?
To sell the rip means to sell an asset — which could mean either closing an open long position or opening a short position — when its price has risen to a level considered overvalued.
This investment approach follows the basic principle of “buy low, sell high,” but in this case, the focus is on the selling aspect. The sell the rip strategy is based on the idea that an asset can get overvalued and overpriced, which makes it rip for price correction or even a market crash.
The “Sell the rip” strategy is used by investors and traders who already have an existing long position of an asset and have ridden the bullish sentiment (what are market sentiment and sentiment indicators?) to a level where they feel that the market is overstretched and unreasonably overvalued. When the market is overvalued, the best thing is to sell because a market correction or at least a correction would soon set in.
The strategy can be used for any asset; however, when trying to short-sell a stock, it is better for stocks with weak fundamentals that have been overpriced due to larger market sentiment or overreaction.
Investors use the strategy to go short on weak stocks that are unduly overvalued, hoping that the market will eventually correct itself and sell off on those stocks. When the stock eventually falls in price, they can buy them back at lower prices and pocket the difference as their profit.
However, note that stock prices theoretically have unlimited upside, so the risk and reward of short-selling should be constantly evaluated — even stocks with weak fundamentals can unexplainably continue rising. Smart traders who use this strategy base their decision on when to sell the rip on careful research and backtesting.
The sell the rip strategy has been around for a long time, especially among short-term traders, such as scalpers, day traders, and swing traders (however, we believe scalping is a waste of time).
For stocks with good fundamentals and huge growth potential, the sell the rip strategy is not a good approach, even for taking profit, as you will likely leave a lot of profit on the table when the stock continues to rise — who says that a stock that has made a 100% profit cannot make a 1000% profit if left to run. The sell the rip strategy is not good for long-term investing.
Is selling the rip the same as selling the rally?
Yes, sell the rip is the same as sell the rally because both are about taking short-term profits made from a price rally. Technically, though, the “rip” doesn’t just refer to a rally but an overpriced/overvalued market.
Sell the rip strategy is looking to sell into an overbought condition, not just selling on any rally. Selling a lot early would mean leaving money on the table, and for short-sellers, it could even be catastrophic if the price keeps rising to hit their stop losses. The approach is used by short-term traders who want to quickly book profits before a market correction sets in.
Buy the dip sell the rip – mean reversion
Sell the rip is one-half of the “Buy the dip, sell the rip” slogan in the crypto market or the “Buy low, sell high” version in the stock market. The strategy works on the principle of mean reversion strategies, which implies that the price oscillates about its mean. When the price moves significantly above or below its mean, it becomes overvalued or undervalued.
So, when the price moves significantly above its mean, it is likely overvalued and overpriced and a correction might be about to set in. for short-term traders, that is the time to sell and book profits.
For short-sellers, the overvalued condition creates an opportunity to go short and book profits when it falls back to its mean.
The best Sell the rip indicators
The trading indicators you can use for the sell the rip strategy include oscillating indicators and momentum indicators. Such indicators can show oversold and overbought conditions in the market. You may use them in combination with the moving average indicators, which can show the price mean. Bollinger Bands is unique in showing both the mean and the oversold/overbought conditions.
Here are the most common indicators for trading the buy the dip strategy:
- Relative strength index (RSI): This is a popular momentum oscillator used by many short-term traders. It compares the number of days the price closed bullishly to the days it closed bearishly within a specified period.
- Stochastic indicator: Another popular momentum oscillator used by traders. It measures the current price close to its range over a chosen period.
- Williams R%: Williams %R is a momentum indicator in technical analysis that measures overbought and oversold levels. It is similar to the stochastic oscillator in how it uses price range in its calculation. In fact, it is the inverse of the fast stochastic indicator line.
- Internal bar Strength (IBS): The Internal Bar Strength indicator is an oscillator that measures the position of the current trading session’s close relative to the trading session’s high-low range.
- Bollinger Bands: It has three bands, including a middle band that shows the price’s mean. The upper and lower outer bands can indicate overbought and oversold market conditions, respectively.
- Moving average strategies: This continuously measures the average price as new price data come up with every new session.
Sell the rip strategy backtest – does it work?
The best trading strategies emphasize the exit – not only the entry. That makes sense. One part is when to enter a trade, and one part is when to exit. Both are equally important, in our opinion.
However, most blogs and articles focus on the former – when to enter a trade. There are many ways to exit a trade, though. For example, you might have a sell the rip exit, but you might also include a stop management criteria. We have covered exits in previous articles and you might want to have a look at them:
- 5 Exit Strategies in Trading
- How To Enter And Exit Positions At The Close
- Stop Loss Strategy – Pros And Cons (Stop Loss Options)
Let’s go on to make a specific sell the rip strategy backtest with specific trading rules and settings:
Sell the rip backtest
We have mentioned that RSI trading strategies work well, especially on stocks, because of their mean reversion capabilities. Let’s go on to backtest such a mean reversion strategy: We backtest the following sell the rip strategy based on the RSI indicator (on SPY – S&P 500):
- When the 3-day RSI is below 30, we go long at the close.
- When the 3-day RSI crosses above 70, we sell the rip at the close.
The equity curve (the equity curve is the visual or graphical representation of your equity) of this simple strategy looks like this:
Although the strategy shows some promise, it’s far from tradable, in our opinion.
We change the strategy and make the following trading rules:
- When the 3-day RSI is below 30, we go long at the close (same as before).
- When today’s close is higher than yesterday’s high (we sell the rip at the close).
Does the new exit criteria change the strategy? Yes, the equity curve improves – a lot:
We would say this is a radical improvement! This happens despite a drop in the expected average gain per trade (0.48%). The reason for the improvement is that our holding time goes down, and we sell on the lesser but more frequent “rips”. Additionally, because we sell sooner, we get more trades.
Sell the rip strategy – when it doesn’t work
Our example uses the S&P 500. For the past three decades, it’s been very profitable to buy the dip and sell the rip. Before the 90’s it was less so.
Also, in other markets, for example, commodity markets, it’s less likely you’ll be successful with selling the rip. Those markets tend to follow a trend following pattern and you’ll end up selling prematurely very often. A backtest normally solves the best approach for each market.
Sell the rip code
We have provided Amibroker code for our sell the rip strategy backtest. We sell the code together with over 100 other different trading ideas and strategies:
The code also comes in plain English if you prefer to code yourself using Python, for example.
Alternatively, you find all our products in our shop.
Sell the rip strategy – ending remarks
We hope that our blog post has shown you the importance of having a proper sell signal and when to exit a position. The sell the rip strategy backtest shows that a different exit signal can make a profitable trading strategy.