First and foremost, this setup works best in a range environment when overbought and oversold readings are far more likely to be true signals of a change in direction. Secondly, as we will see from several examples in this chapter, the setup is much more accurate on the daily charts than on smaller time frames like hourly charts. The primary reason for this difference is that daily charts incorporate far more data points into their subset and, therefore, turns in momentum tend to be more meaningful on longer time frames. Nevertheless, the asymmetrical structure between risk and reward in this setup makes even the shorter time frames worth considering. Just keep in mind that although the setup will fail far more frequently on the shorter-term hourly charts than on the daily ones, the losses will generally be far smaller, keeping the overall risk manageable.
Rules for a Long Trade
1. RSI reading must be less than 30.
2. Wait for an up candle to form and close with an RSI reading greater than 30.
3. Go long at market on the open of the next candle.
4. Place your stop at the swing low.
5. Exit half of the position at 50% of the risk and immediately move the stop on the rest to breakeven.
6. Exit the rest of the position when one or the other following condition is met:
a. Stopped at breakeven
b. Trade first moves into overbought territory marked by RSI readings of greater than 70 and then eventually drops from that zone. As soon as RSI declines below 70, sell at market on the close of that candle.
Rules for a Short Trade
1. RSI reading must be greater than 70.
2. Wait for a down candle to form and close with an RSI reading less than 70.
3. Go short at market on the open of the next candle.
4. Place stop at the the swing high.
5. Exit half of the position at 50% of the risk and immediately move the stop on the rest to breakeven.
6. Exit the rest of the position when one or the other following condition is met:
a. Stopped at breakeven
b. Trade first moves into oversold territory marked by RSI readings of less than 30 and then eventually rises out of that zone. As soon as RSI increases above 30, buy at market on the close of that candle.
The key to this RSI strategy - versus the traditional interpretation of RSI, which simply trades overbought or oversold levels - is to first look for a reversal candle, which provides us with a sign of exhaustion before taking the trade. This way, we are prevented from prematurely picking a top or bottom and instead wait for indicator confirmation.
Note that the RSI rollercoaster is designed to squeeze as much profit as possible out of the turn trade. Instead of immediately closing out a position when it moves from oversold to overbought condition, the RSI rollercoaster keeps the trader in the market until price shows a sign of exhaustion. Sometimes a strong move will generate multiple consecutive periods of overbought RSI readings, and this setup is specifically intended to catch part of these potentially profitable moves. Note also that the RSI rollercoaster is almost always in the market, as the rule for the liquidation of a long trigger is the creation of a fresh short position. The only two times this setup stays out of the market is when the trader is stopped out of his position on a false signal or when he is stopped out at breakeven on the second half of his position.
Read More : RSI Rollercoaster
