Trading strategy · Mean Reversion

RSI Mean Reversion

Buy temporary fear inside a strong uptrend.

Level: BeginnerTimeframe: 1H to DailyStyle: SwingMarkets: Stocks, indices, ETFs

What it is

The Relative Strength Index (RSI) measures how stretched recent price moves are on a scale of 0 to 100. Below 30 is "oversold". This strategy waits for a healthy uptrend, lets a sharp dip push RSI below 30, and buys when RSI climbs back above 30, betting that price snaps back toward its average.

How it works

• Use a 14-period RSI. Readings below 30 are oversold; above 70 are overbought.
• Only buy oversold readings when the long-term trend is up (price above the 100 or 200 SMA).
• Wait for RSI to cross back ABOVE 30. Buying while it is still falling is catching a falling knife.
• Stop below the low of the dip.
• Exit when RSI reaches 50 to 70, or when price returns to a recent high.

Pros

• High win rate in trending markets
• Buys at a discount
• Simple, objective rules

Cons

• Small wins relative to losses if the trend breaks
• In crashes RSI can stay oversold for a long time
• Needs a trend filter to work

Common mistakes

• Buying oversold in a downtrend
• Buying the moment RSI hits 30 instead of waiting for it to turn up
• Using no stop because "it must bounce"

Lesson transcript

Lesson four: RSI mean reversion. This strategy does something that feels uncomfortable. It buys when everyone else is scared. But it does it with strict rules. First, the trend. This market has been climbing for weeks. The orange line is the one hundred period moving average. Price is well above it, so the big picture is bullish. We only look for buys. Below the chart is the relative strength index, or RSI. It measures how stretched recent moves are, from zero to one hundred. Above seventy is overbought. Below thirty is oversold. Now a sharp dip. Price falls fast, and the RSI drops below thirty. Oversold. But we don't buy yet. Buying while it's still falling is catching a falling knife. We wait for the RSI to cross back above thirty. That tells us selling pressure is fading. Here's the signal. We buy, and our stop goes just below the low of the dip. And price snaps back toward its average and resumes the uptrend. We take profit when RSI reaches sixty to seventy, or when price returns to the prior high. The rules. Long-term trend up. RSI dips below thirty, then crosses back above. Stop under the dip. Take profit near sixty to seventy on the RSI. The biggest mistake with this strategy is ignoring the trend filter. In a downtrend, oversold can stay oversold for a very long time. The filter is not optional. Next lesson, momentum with the MACD.

More lessons

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