40 weeks RSI (relative strength index)

The RSI is a momentum indicator. investigate two different strategies:

Strategy A (absolute): Buys a stock when the 40 week RSI rises above 30 and sells short the stock when it drops below 70. All positions are held for 10 weeks. The performance relative a simple buy and hold strategy is as follows:

average buy and hold performance p.a. = 7.6%
average RSI strategy performance p.a. = 0.3%
average strategy outperformance p.a. = -7.3%

Strategy B (divergence): Buys a stock when the 40 week RSI rises from 25 to more than 30 within 5 weeks and at the same time the stock price falls. The position is held for 10 weeks. Similarly we sell a stock when the 40 week RSI falls from 75 or more to less than 70 within 5 weeks and at the same time the stock price rises.

The performance relative a simple buy and hold strategy is as follows:

average buy and hold performance p.a. = 7.6%
average RSI strategy performance p.a. = -0.05%
average strategy outperformance p.a. = -7.7 %

The strategy looks very appealing when presented with the right stock at the right time, but when we apply it mechanically for a long time, it does not appear to be working. On the contrary, it leads to a statistically significant underperformance to a simple buy-and hold and to a return that is not statistically significantly different to zero, according to the Wilcoxon Sum-rank test.

The reason for the underperformance must lie in the fact that the S&P stocks generated a significant return over the last 30 years. When we interrupt those returns in an apparently random pattern (such as when applying the RSI) and even go short half of the time, it clearly leads to a significant underperformance of a simple buy-and-hold.