New Research On RSI(2): A Profitable Indicator?

As many traders know, many indicators are often representations of similar measures. I prefer to not get bogged down with multiple measures of a trend. To keep things simple, I typically monitor price and volume, MACD, RSI, and sometimes the Stochastics. While the MACD can help traders judge the strength of a trend and also identify when a new trend is beginning, the RSI is often used to help with timing, i.e., when to get in, and when to get out of a trade.

Because of its simplicity, the Relative Strength Index (RSI) is one indicator that has always made intuitive sense to me. The calculation is simply the average of x days up closes / x days down closes. What traders have often differed on is what average to use. The default with most charting software is 14 days. However, several bloggers have advocated, or at least discussed using a 2 day average. I know Bill Rempel, Bullish Jim, and Marlyn from Filtering Wall Street (no longer being updated) have all presented trades using the 2 day RSI.

Finally I have come upon some research which shows the benefit of using a 2 day RSI average. In the November issue of Technical Analysis of Stocks and Commodities, an article by Larry Connors and Ashton Dorkins describes the results of testing more than eight million trades from January 1, 1995, to December 31, 2006. The average one week percentage gain or loss for all stocks during the period tested was +0.25%.

After quantifying overbought and oversold conditions (RSI above 98 is overbought; RSI below 2 is oversold), their research showed that stocks with a 2 period RSI below 2 averaged a gain of +0.88% one week later (beating the benchmark average by more than 3:1). Conversely, stocks that were overbought with a 2 day RSI greater than 98 lost money (-0.17%) one week later as well as underperforming the benchmark.

The implications of this research are crystal clear: Traders should use a 2 period RSI if they want the indicator to actually give them an edge.

After reading this article, I set out to find a stock with a 2 day RSI below 2. I could have just programmed Stockfetcher (I think) to find some. However, that would have been too easy. I instead decided to pull up some stocks that have recently taken a beating. After the plunge VDSI experienced, I was certain it would make a good RSI<2 candidate. No luck there, as the RSI(2) was at 9.5.

Then I remembered WCG. Bingo! The RSI(2) is at 1.14.

The chart, which shows WCG losing 70% of its value in three trading days, shows why the RSI(2) works so well. When a stock is trading at extremely oversold levels, the most likely direction for it to go is up. While WCG would definitely be a buy if one was trading using the RSI(2), the fact that the stock is under a government investigation for alleged Medicare and Medicaid fraud right before the start of the enrollment period may mean that the normal bouncing process may not follow through in this particular name.

I intend to incorporate the RSI(2) in all future technical analysis.

2006. Connors, L. and Ashton Dorkins. "Does the RSI give you an edge?" Technical Analysis of Stocks and Commodities. 48-52, November, 2007.

X Marks The Spot

The Nasdaq put forward a very strong move today. Volume accompanied the move, the first time in several months that the index has seen good volume on a move up.

In my previous post here at Trading Goddess's, I suggested an area which the Nasdaq might find support. The index did not yet make it down to those levels. This shows a great deal of strength, though it is certainly possible the Nasdaq may dip from here and visit the 2600-2650 area.

In the chart above, the bottom line represents the uptrend established from the August low. This uptrend was firmly punched through on Friday, October 19th. The upper line is the resistance set from the October high.

This analysis shows the index at a critical moment. The Nasdaq managed to close just slightly above resistance (or right at it, depending on where you draw your line), and closed just below, (or right on) the uptrend line.

A strong showing over the next few days should put the Nasdaq above both lines, and will mean the recent pullback was just another buying opportunity. Failure to overcome the resistance line suggests further retracement is likely.

Basically, if you are short, this is where you stick it to the bulls. If you are long, this is where you ram it to the bears.

The next few days should be very entertaining as both camps fight for dominance.

MVIS Printing Multiple Bullish Divergences

Today MVIS had a swell in volume to levels not seen since August. The stock dropped and retested its August lows. While this breakdown from tight Bollinger Bands could cause one to be concerned, the chart is showing many bullish divergences.

While the stock has continued to make lower lows since the end of August, the MACD, RS, and Stochastics have all bottomed and have turned up. As buyers stepped in today and picked the stock up from its lows, its probable that a trend change is near.

Also, it was within a few days of today's date in October of 2006 that MVIS began its run which saw it rise 125% by the January CES show.

20-Day Play: EHTH

In order for a stock to make The 20-Day Play, it must trade above its 20-day simple moving average for at least 20 days, and then bounce on or near the 20-day average.



EHTH saw its IPO just one year ago. After finishing a cup-shaped pattern, the stock has pulled back to its 20 DSMA. This touchdown is also a revisit of a pivot point.

Last week's 20-Day Play, DAR, is still in play.

Wood Buy: KTEC

Yesterday I established a small position in KTEC after Fly mentioned it. He even offered up this research report from Needham.



The stock broke out to a new 52 week high today, although the volume was weak. In fact, volume has been weak during the wedge created in September and October. Due to the weak volume and wedging action, I've only committed 100 shares to this stock.

The Bollinger Bands (not shown) are tighter than they have been in 6 months. As you know, tight bands mean a greater likelihood of increased volatility. Should volume move in, I think there is the possibility of a large upside move.

20-Day Play: DAR

The 20-Day Play seeks to capture a stock that has consolidated momentum and is ready for another leg up. Specifically, the stock will have traded above the 20-day simple moving average for at least 20 days and will be set up to bounce from the average.



DAR certainly meets the basic screen necessary for the 20 Day Play. However, the RSI and MACD are both showing signs of possible weakness ahead. Be careful as more consolidation maybe required before DAR can continue moving up.

Also present is the almost symmetrical reverse head and shoulders pattern.

Overall, I find this stock worth watching to determine if the 20 day average will begin to offer support as it did in March, April, May, and June.

New Position: AKRX

This position was initiated purely for technical reasons.

The stock was pointed out to me in the comments section by Brent, of Sierra Mountain Investor fame. I'd hyperlink to his blog, except that he has it offline right now. I have to say Brent has some fantastic picks, and we'd all be doing better if he'd put his blog back up.





As you can see, AKRX has been consolidating near resistance, and depending on where you drawn your lines, has either pierced resistance, or is bumping its head on it.

The blue arrows show the high volume days over the last 6 months. If the stock were to see another high volume day as it did in the past, it might be launched upward, making a clean breakout. And that is what I'm looking for this one to do, breakout.

Fundamentally, this stock is a biotech, and because of that, can be prone to surprises which may be deleterious to one's account value.

Update: Sierra has his blog back up.

Position Update: PTT

I've added a suggested trading range to the chart. It looks to me as if PTT has completed a pullback to support. While the pullback swung my account to a loss of $500.00 in the position, I stayed with it. I do not typically let trades turn into losses much greater than $500.00, so it was do or die. Indeed, PTT bounced, albeit from about .35 cents lower than I had hoped it would find support.

As long as the indexes do not begin a new leg down, and PTT continues to move back up, I am looking to see $10.00 before another pullback.

I Love the 20 Day Simple Moving Average

The 20 day average is a favorite of mine. As the center line for the Bollinger Band (or the average of 2 STD of volatility), the average can alert traders when a stock has reached a normal price range, relative to recent movement. This positioning of price in the not too hot, not too cold, but just right range seems to propel stocks that have momentum.

A recent example is LWAY. This stock has been a phenomenal earnings and momentum play. The gigantic breakouts on killer volume should have been enough to earn this stock a place on any breakout trader's watch list.

I missed the first move to 17, but resolved myself to keep watching the stock for a pullback, as stocks that breakout on huge volume tend to keep going up for a while.

I made the first purchase on September 19th, as the price was approaching the 20 day simple moving average. I was immediately rewarded with a huge move. The stock spent the next week or so consolidating the move, and I again waited for the price to approach the 20 day average. On Friday, I added to my position as LWAY look primed to move again.

I was rewarded Monday with a huge move. Today, I sold half my position for a ~30% gain.

I have extended a hypothetical 20 day moving average on the chart so that one might imagine what LWAY will do next.

New Position: GES Short

Why short GES? I mean, the stock has been a serious retail powerhouse, right? And in the process of achieving a greater than 100% return in a year's time, the stock split, institutions accumulated, so on and so forth. The stock still has a huge insider sponsorship, and good revenues and earnings.

So why short it?

Simply put, because their advertisements for men make me want to spew.

Consider the above gem as an example of everything that is just plain wrong. Is this dude looking for some man-boy love in a freaking desert? "Come here, and watch me ride this gnarly 3 inch thick manilla rope...You don't mind a few slivers of manilla in my craw, do you?"

Do I need to mention that a rope that size is used to tie up huge ships?When is the last time you saw one of those docked in a desert? Makes you wonder what or who he plans on tying up. Maybe he is a chubby chaser.

Look closely and you'll see he is holding a leopard print scarf. What the hell is he going to use that for? "Hey boy, let me blindfold you with this leopard print bandanna, stuff you in my beat up pressboard trunk, and ship you over to my basement apartment for some good times. Oh, and don't mind the sand in your crotch."

Looking at the chart, I find many things that make me want to hit the short side, such as the massive triple top, the declining relative strength, negative MACD divergence, and the large-volume sell-off after earnings. Not to mention, the retail sector as a whole is not looking very hot.

I sold short on Friday, and will look to add to the position if it gets anywhere close to $50.00 As a target, I see 43.00 as a good place to cover.

Keep in mind that GES has been strong and may have a few good jabs to the upside left, although I would be really surprised to see the stock get anywhere near new highs anytime soon.

New Position: BLUD

I have watched BLUD for a break to new highs since January. Its appearance last week in the IBD 100 (ranked 98, I believe) may have been what it need to break out to new highs.



This 3-year weekly chart shows a long saucer bottom, followed by a break out. The stock has consolidated the previous breakout for 9 months.



This 1-year daily chart shows BLUD breaking out out from a 9 month rectangle consolidation.

If a stock makes the IBD 100, one should know that the metrics are strong, but I'll make it easy and link to them here.

New Position: TRAK

TRAK caught my eye last week in the IBD 100. It was one of few stocks which were not over-extended above a recent base. The chart looked prime for a breakout, so I added it to my watch list.



The stock has completed a clean breakout, although the volume on the move was not spectacular. The company DealerTrack Holdings has no debt and is growing revenues and quarterly earnings at a pace of 35% year-over-year.

Watch Wallstrip tackle TRAK here.

Titties and Beer

Thank god I ain't queer.

No offense to women, alcoholics, or homosexuals.

If the chart is not enough to make you happy, then look at these metrics. I mean, what's not to like? A low-float company with 32% insider ownership and 36% institutional ownership, growing quarterly earnings year over year at 236%? Surely that's enough to give one a woody (no pun intended), even if you are not into strip clubs.

By the way, for any of you out there who are too high class, or moral, or whatever, and have not visited a titty bar, let me tell you that the jokers that visit these places spend loads of cash, and they are typically repeat customers. For a lot of the clients, visiting a gentlemen's club is equally addictive as drugs or alcohol.

I'm long PTT with what is likely a half position. I would like to see resistance broken around $9.00, and then buy more on a pullback. Hat tip to Sierra for this one.

Watch tonight's CNBC video on RICK right here.

MVIS- Volatility Squeeze Please

MVIS- Volatility Squeezes

Everyone knows I'm a big fan of MVIS. For better or worse, it has been a core position of mine for 2007. I've noticed that the stock responds well to volatility squeezes. As I noted in a previous post, MVIS was setting up for another squeeze. It looks as if the move came to fruition in today's trading.

What is a volatility squeeze?

As a stock consolidates, the daily ranges begin to decrease. As these ranges get smaller and smaller, eventually the 20 day moving average will catch up with the price. As the stock hovers around the 20 day average, the Bollinger Bands will begin to tighten around the price. Tightening of the Bollinger Bands show that the standard deviation of movement (volatility), measured relative to the 20 day moving average, has decreased. For more information on Bollinger Bands, go here.

Like all things in the market, volatility comes and goes. But before a stock can become volatile, it must have consolidated. The volatility squeeze, as measured by tightening Bolligner Bands, shows that a stock has consolidated and is possibly subject to increasing volatility. Keep in mind that increasing volatility does not mean that the stock will go up. It could just as easily go down. I typically trade with the trend, so if the trend is up, I expect a squeeze will be to the upside.



On this chart of MVIS, I've put blue arrows everytime the Bollinger Bands tightened. With a couple of exceptions (notably the big move in July) tightening Bollinger Bands have brought higher prices.

The volatility squeeze is an easy play and can be identified with an indicator which is readily available on charting software. A stock with a strong uptrend will typically experience many squeezes over the course of its rise. However, a stock in a downtrend will experience the same squeezes, which will typically lead to lower prices. Finally, a stock which has experienced a fantastic rise and eventually rolled over may experience a prolonged period (many months or even years) of tightening bands, while never breaking out of the range. Take a look at ERS to see what that looks like. When ERS finally breaks out from its volatility squeeze, you can see it follows the primary trend- down.

For The Chart Chompers: MVIS

I have realized that this blog has not had enough charts featured lately.

Lets take a quick look at MVIS.

First of all, the stock has held up remarkably well in the downturn. I feel the key point is the volume, or lack of it. It seems the sellers have dried up. If the stock stays at this level for a few more days, a volatility squeeze will be in order.

Another way to look at this is the descending triangle. Typically, these are bearish patterns. However, I think a case could also be made for a bull flag. It all depends on where you want to draw your lines...Ah...the beauty of technical analysis.

Anyway, both the RSI and the MACD are showing signs of a bottom, even though the price is not. I'm going to go out on a limb here, and predict that, due to the lack of sellers and the volume drying up entirely, that news is expected very soon, perhaps within days.

Let me temper that prediction with some rational discourse and state that should support at $4.50 be broken, MVIS could see the 4.20s very quickly, much as I dreamed about the other night. However, I would think that if the sellers wanted to take it there, that they could have easily the last few days. Thus, I'm sticking with news coming, soon.

Beulah the Market Hag

Can anyone identify the 5 Fat Girls candlestick formation?

Why not just go for a 10% percent correction?

What really scares me is that the fundamental credit crunch may over-ride the technicals, even after falling 10%. However, it seems likely the asshole dip buyer will at least make a showing at that level. We'll just have to see how many more Countrywides out their skeletons.

The Trend Bends

Damn, I feel much better after today's action. We got confirmation today- the trend has bended, and it seems likely that there will be another leg down. See, unlike Vick, I don't really have a dog in this fight, (well, maybe a small dog) and so if the market falls, it does not destroy my account. Since I have about 70% cash, I can watch the action and remain fairly detached. I have to admit my stress level is declining, and I'm getting my goals met at work. Also, I like it when I paint a scenario and it actually plays out the way I paint it.

Let's look at a chart of the Nasdaq. You might wonder why I prefer the Nasdaq over the SPY or Dow. Well, many believe the Nasdaq leads in and out of rallies and corrections.

It is clear that today was a HUGE reversal today. That is one UGLY candle. However, the market internals from today were not as bad as one might think. I do not think it was a capitulation day. Based on the MACD and the RSI, the capitulation day may come tomorrow. Be careful though, as this trend is shaping up to be strong, and may need some time to work off the downward momentum.

Another 100 point decline will give the Nasdaq the 10% correction that the bears are rooting for. Honestly, what is another 100 points after last week's clobberage?

I still think this is a difficult market to trade. I'm staying away from individual stocks (unless one just screams to be traded) and sticking with the inverse ETFs. Today I picked up 200 QID and paid around $45.50 for it. If I can even squeeze a couple of points out of it, I'll be happy. After all, if one can preserve capital during these corrections, and then employ that capital on the rebound, he or she will do well. Any money made on the drop will be icing.

The key points here are that most indicators are showing a market that is near oversold. However, the volume and overall strength of this move could keep the market in oversold territory for some time before a tradeable bounce occurs.

Today I also closed out my ANAD position. I bought 200 more shares on the dip, in case the day turned out to be a buying opportunity. When it became obvious that the market would reverse, I sold all 500 shares for a small loss. I also bought and sold 200 SWHC for a wash.

The Best Offense Is....

You did not really think I would finish that cliche aphorism in the first line of this post, did you?

Although, I do think that playing the market defensively is appropriate in the near term.

It is too early to go short. Traders are likely to get whipsawed doing so. It is also too early to be buying aggressively, as I feel more downside is possible. Therefore, I will stick with a large cash position, while nibbling gingerly on a few carefully selected issues.

Whether the consumer is broke, or whether the CDO issue will blow up accounts across the globe is really just impossible to determine with any certainty. Why try to figure out how a host of variables, all of which seemed to be inextricably linked (but truly are not), will affect the markets? By the time everything is truly understood (if ever), it will be too late.

Instead, I think it makes sense to watch carefully to see if the current leadership is maintained, or if new leaders begin to emerge. Also, if one has a strong feeling the market is going to move one direction or another, but is having trouble determining leaders to buy or short, I might suggest getting long or short an index, such as the QLD or QID. The moves will not be as large, but one is less likely to miss out entirely while trying to cherry pick good stocks. Hat tip to Bill Rempel for that simple trick.

Finally, it should be noted that my time horizon is not very long- typically I do not want to hold a stock for more than 2 months. If your time horizon is much longer, this is probably a huge buying opportunity.

Today, I picked up 300 shares of ANAD. As I am currently playing things very carefully, I did not establish a large initial position. I will add more shares if the stock continues to hold its ground. What I'm looking for here is a quick percentage move which will allow me to book some gains while the market figures out where it is going.

ANAD had a nice move up after a good earnings report last week. With earnings as a catalyst, and the large volume gap up from a sound base, I feel this one may keep moving.

Evening Wrap Up

Well I ended up buying higher. Not a lot, just a little GIGM, 250 @ 13.3475.

Although I'm beginning to wonder why I'm waiting for a little pullback, as the strength in the Nasdaq was incredible, with the volume swelling. All this on a July day, and an options expiration week.

I'm likely to take Boone's advice and just start pulling the trigger on stocks offering good entries.

One I really like is Lubrizol. Fly has offered it as his "gun to the head" pick. The chart is really nice, and the name is sexy. They report next Friday.