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Trading System based on the Linear Regression of the RSI Indicator
Applying the linear regression to the 2-Bar Relative strength index series creates an oscillator whose values vary between 0 and 100. The oscillator reaches low values after a decline in the underlying stock and reaches high values after a fast increase.
Linear regression analysis is used to analyze the relationship between two variables. In technical analysis, it is used to determine the trend of a time-series. A high value is an indication that the applied variable is trending up.
This trading strategy generates buy signals when the oscillator value (Linear regression applied to the 2-Bar RSI) becomes lower than 10. Besides this simple rule, a liquidity rule was added to prevent the strategy from buying illiquid stocks.
The sell rules of this trading system consists of a two stop rules: a 10% profit stop and a 100-Bar stop (This means that any position will be sold if the holding period exceeds 100 trading bars).
More information about this trading system:
- All U.S. stocks except those that are listed on OTC markets are analyzed
- Trading system type: Long only
- The maximum number of positions is 10
- No money management strategies were defined
- A long ranking system was applied to this strategy. The ranking system formula is the multiplication of the close price and the 5-Bar SMA of the volume
Backtesting results:
During the 2001-2011 testing period, the trading system generated 395 traders, 76.55% of whom show a positive gain. The annual return is 26.34% and the maximum drawdown is 45.76%.
Average bars held = 47
Ulcer Index = 11.34
Sharpe Ratio = 1.06
Profit Factor = 1.62
Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.
