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RSI DIVERGENCE STRATEGY
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Guys I am fairly new to trading, I trade WTI crude oil on MCX. I built an intra-day M15 strategy on RSI divergence. So the strategy is as follows:
Indicators used:
- RSI 14 period (OB 80, OS 20)
- Stochastic (5,3,3) (OB 75, OS 25)
- Average True Range 5 period
- M15 chart
The steps are
- Find a RSI divergence, any divergence.
- Enter trade when Stochastic crossover in preferred direction. (Note only if Stochastic has touched either 30 or 70 before or during crossover)
- Set target as 2 X ATR (5 PERIOD)
- Set stop as 2 X ATR (5 PERIOD)
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In my analysis I found that it was easy to find a divergence but to pin point when the price would react to the divergence was difficult, so I added a 5,3,3 stochastic as a confirmation of reversal. Then I found that setting target and stops was also an issue. So I added ATR for stops and target based on volatility.
The risk to reward was initially 2:1 (targets 3 X ATR and stops 1.5 X ATR) but the price would either whipsaw within a few points of my target or just hit the stop right away. So I changed in to a 1:1 (target 2 X ATR and stops also 2 X ATR)
Now I am trying my best to test and fine-tune this strategy. I would love to have your input. Any suggestions for indicators or any other stuffed is warmly welcome.
Thanks in advance.
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I think you’re probably not such a random potato as you claim, but quite a well cultivated one. This is all based on good, sensible principles and could be made to work.
I can make two suggestions.
Firstly, in my experience (and according to what I’ve heard from colleagues, too) RSI-divergence-based entry-methods for forex trading work much better and much more reliably if you make the lookback period about 22-25 periods, rather than the 14 periods you’re looking at now.
Secondly, although it’s a much smaller point, you’ll need to be very careful in avoiding anomalies if you calculate the ATR over only 5 periods. ATR-10 or ATR-15 makes only a little difference, but it does help to minimize the impact of any unexpected, individual, extra-long candles, by “diluting” their effect on the calculation.
I think you have the stochastic settings about right - something like 6/3/3 or 6/3/2 or 5/3/3 or 5/3/2 or 5/2/2 is usually about right, for this kind of idea.
I think you’re right to make the targets and stops about 2*ATR, and aim for a win rate above 50%.
Positioning the initial stop manually according the level of the most recent S/R would clearly work out better, overall, but it’s more work and much less convenient for automation and/or one-click trade-entry.
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Agree
RSI-22 and stoch 5-2-2 is going to be much better. Test it and see? (Also agree ATR-10/15, but the important thing is to watch it manually and allow for situations where the “average” is distorted by a thrust bar, etc.
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Firstly, thanks for the input, I’ll test it out for sure.
Secondly, I have been trading equity for the past 2 and a half years, was just playing around, no system, wasn’t profitable either. I later switched to Commodities (my country doesn’t allow leveraged forex trading, the pairs traded are only 5 and that too for limited hours).
So when I switched to commodities I figured out that there is no way one can make money without a proper system, moving averages and MACD aren’t going to cut it.
I used to hate RSI before I figured out how powerful RSI divergences are. Now I’ll work on it maintain a journal and hopefully trade only commodities starting next year.
Thanks mate 
Thanks for your input mate
So after changing the periods to RSI(25) and Stochastic(5,3,2),
The 25 period RSI mimics the price really well, which helps ignore false signals. The Stoch (5,3,2) is much smoother than a 5,3,3, or a 6,3,3 which helps to ignore whipsaws.
I found that the number of entries reduced. However, the signals were much better and false signals have now come down. I also found that when strong trend emerges the RSI divergence for a counter trade hits one stop after the other until the price finally reverses.
So to mitigate this, I’ll try and go for a 2:1 or maybe a 1.5:1 reward to risk ratio and test it for next 2 weeks on paper. I’ll also try to manage stops actively so that I can trail and profit as much as possible from the trades which actually play out well, rather than having a fixed target.
I’ll also test CCI for divergence trades.
Thanks to @LukasVisser and @LaughingCharlie for the information and experience they shared.
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Finally I made the shift from RSI to MACD Histogram divergence. Normal settings, but just the histogram. It is easier to find divergences on MACD, unlike RSI you don’t end up comparing ripples for divergences.
Then again my struggle with target and stop loss continued. So I figured that playing a divergence trade on the primary trend is much more profitable that playing a counter trade unless you catch a reversal.
So to determine primary trade I put on a 100 Simple Moving average and 100 Weighted Moving average crossover. I’ll be testing this for the next two weeks. From what I have found till now, trading divergences supported by the trend is much safer and ignores whipsaws. It might be difficult to find a such a divergence but the target is hit even if it takes double the time.
Now I’ll be looking at bullish divergences only if the WMA is above the SMA and vice-versa.
Will post images soon.
Happy Trading!
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Everything you say there makes very good sense, certainly. Hoping it goes well for you!
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I tried testing the MACD histogram thing using trade interceptor yesterday, the results weren’t very favorable.
Man it just gets so infuriating at times. But when I try it on MCX timings that is from 10:00 to 23:45(GMT+5:30) it kinda works, but not satisfactory when it comes to NYMEX WTI.
I’ve felt your pain. Years ago, when I was using indicators, I would get frustrated because they never told me what I really needed to know-- where to pull the trigger on the next trade. For example, by the time the MACD crossed over, it was time for the market to take out my stop and go the other way!
When I learned how to see what the market was doing with the current price action, I became profitable. I now use only a 20 EMA as a reference point. I am convinced the most profitable traders in our industry are not relying on indicators.
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I tried the SMA and WMA crossover thing, it kinda works fine.
The other aspect of using moving averages is which I found to be useful is determining primary trend and then if I get a counter trend trade I will go on with a 1:1 risk to reward as opposed to a 1:2 in case of a trade in the direction of the trend.
If the price is above the MAs and I get a bearish divergence I will look to book profits as soon as possible i.e. 1:1 risk to reward, not setting targets too far away.
I’ve never been a huge fan of price action, it seems like to good to be true, I mean like clean naked charts and stuff.
Will surely look into it now.
Any recommendations maybe books or something?
Thanks
Read all the reviews available on Amazon, good book, but can get a little tedious in sections
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I completely agree.
If you want to learn the main principles of price action, I’d definitely recommend this book as your first one on the subject.
Volman’s other book is very good, too.
After those, there are Al Brooks’ books as well: their content’s very good, but they’re much more difficult to read.
There’s also some good free information (and downloads, I think) on Lance Beggs’ website.
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Haven’t posted in a while guys, so here’s an update.
The MACD Histogram thing has been working fine on the 5 min charts both on commodities and equities. So I have been trying it on Indian equities as well.
The SL is just one or maybe two points above the swing high. The target is 2 times the risk, which means the risk to reward is always 2:1.
The thing didn’t work well on 15 min charts, but now I’m fine with scalping the 5min.
I’ll post some images of the setup in a while.
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So here are the images, the system doesn’t work well in sideways market.
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