I’m going to do an analysis of an indicator called the Relative Strength Index. This is similar to the Money Flow Index discussed in another analysis. You can find how to calculate the RSI on the Investopedia page I linked. A value over 70 indicates the stock is overbought, and expected to be weaker than normal going forward. A value under 30 indicates the stock is oversold, and expected to be stronger than normal going forward.
I’ve applied the RSI to four stocks below (AAPL, BA, CAT, and XOM), for the period 2007 – 2016. That’s a 10-year period that included a major sell-off, a major rally, and some time spent moving sideways.
Before looking at the specific results, let’s discuss what we would expect to see if the indicator has predictive value. We expect that whenever the indicator is less than 30, the average gain over the next N days will be greater than when the indicator is between 30 and 70. We also expect that whenever the indicator is greater than 70, the average gain over the next N days will be less than when the indicator is between 30 and 70.
In the table I’ve included values of N for 5 trading days, 30 trading days, and 110 trading days (about 6 months). Let’s see how the indicator worked out:
|Days < 30||60||60||92||51|
|Days > 70||249||186||212||154|
|Days 30 - 70||2456||2519||2461||2560|
|Avg 5 day Return, <30||+1.59%||+0.06%||+1.13%||+0.04%|
|Avg 30 day Return, <30||+2.46%||-3.49%||+2.11%||+1.29%|
|Avg 110 day Return, <30||+19.79%||-7.72%||+7.25%||+3.32%|
|Avg 5 day Return, >70||+1.40%||+0.29%||+0.36%||+0.14%|
|Avg 30 day Return, >70||+3.94%||+1.56%||+2.22%||+0.48%|
|Avg 110 day Return, >70||+13.73%||+6.93%||+4.76%||+3.83%|
|Avg 5 day Return, 30-70||+0.47%||+0.32%||+0.24%||+0.10%|
|Avg 30 day Return, 30-70||+3.61%||+1.96%||+1.60%||+0.52%|
|Avg 110 day Return, 30-70||+13.39%||+7.70%||+6.79%||+1.68%|
5-day returns with RSI < 30 don’t seem to be any better than 5-day returns with RSI between 30 and 70. AAPL and CAT are a bit higher, but BA and XOM are slightly worse.
30-day returns with an RSI < 30 are a similarly mixed bag. CAT and XOM are stronger when the RSI is less than 30, but AAPL and BA are weaker.
110-day returns with an RSI < 30 aren’t any better. AAPL is stronger, BA is weaker, while CAT and XOM are about the same.
Let’s see if an RSI > 70 has a better predictive value. Recall that a value over 70 is supposed to mean coming weakness in the stock price.
5-day returns when RSI > 70 are almost identical to 5-day returns when RSI is between 30 and 70 for BA, CAT, and XOM, and slightly better for AAPL. There doesn’t appear to be any correlation there.
30-day returns when RSI > 70 were about the same as when RSI was between 30 and 70 for all four stocks. Again, there doesn’t appear to be any predictive value there.
Finally, 110-day returns were almost identical for AAPL and BA, slightly better for CAT, and slightly worse for XOM. Once again, no predictive value is apparent.
In summary, the Relative Strength Index indicator does not appear to have much predictive value.
This is an analysis of past performance, but past performance is not a guarantee of future performance.
Comments / Questions: joseph AT StockMarketMovement.com