Thursday, October 07, 2010

Technical Analysis Killer App?

One often hears the term "killer app" in the high tech world. It refers to any program or application that becomes a necessary part of the platform. In other words, the system just isn't the same with out this application.

Developing the killer app is the goal for most programmers. Everyone now seems focused on the next killer app for Apple's iPhone platform. Traders are also constantly on the search for the next Holy Grail indicator or killer app that will place the odds of success solidly on their side.

In an earlier article, I talked about how the 2-period Relative Strength Index (RSI(2)) is an excellent short term indicator for stock trading (if you missed it, read it here). Our research has taken the basic building blocks of the RSI(2) concept to build a true killer app technical analysis tool.

This tweaked usage of the RSI(2) concept is known as the Cumulative RSIs Strategy. It's a very simple method that has proven itself over extensive testing to be a true killer app in the world of indicators.

Cumulative RSIs are a running daily total of RSI(2) readings. Basically, one adds up the daily RSI(2) figures to get the cumulative reading. The strategy was tested on the SPY from inception to December, 31 2007. The results were impressive. Using a 2-day Cumulative RSI(2) reading of less than 35, 88% of the trading signals proved correct.

In fact, after tweaking the parameters a little, the system nailed almost all of the SPY gains over these 15 years but was only exposed to the market less than 20 % of the time.

You can find further details of these tests in Larry Connors' book "Short Term Trading Strategies That Work".

Does this system work for stocks or is it simply an index based method? We discovered that if you would lower the Cumulative RSI(2) to 10, 69% of the stocks tested showed profits.

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