By now you’ve probably heard of ConnorsRSI, a composite indicator that we developed recently.
If not, you can download a free guidebook on the topic here: An Introduction to ConnorsRSI. Learn everything about ConnorsRSI with our introductory guidebook – including formula & trading strategies.
You may also know that we’ve been methodically replacing the 2-period Wilder’s RSI, or RSI(2), with ConnorsRSI in all of our strategies, because our research has shown that using ConnorsRSI produces superior historical results in our testing.
So how are these two indicators alike, and how are they different?
Both ConnorsRSI and Wilder’s RSI are oscillators whose values vary between 0 and 100. Lower values indicate oversold conditions, while higher values indicate overbought conditions. One question you might have is how often these conditions occur.
The distribution chart below shows the relative frequency with which different RSI(2) values have historically occurred for the stocks currently in the S&P 500. For example, these stocks have closed with an RSI(2) value between 0 and 5 just over 6% of the time. They have closed with a value of 45 to 50 approximately 4% of the time.
The important thing to note here is the shape of the distribution curve. RSI(2) responds very quickly and decisively to price changes. You can see that the indicator spends more time at the extremes than in the middle of its range. You may be surprised that the distribution of RSI(2) values doesn’t form the familiar bell-shaped curve of a normal distribution. In fact, when RSI is calculated with longer lookback periods, the distribution of values does approximate a bell curve. For example, the charts below are for RSI(3) and RSI(14).
Now let’s look at the distribution chart for ConnorsRSI(3,2,100), which may surprise you even more than the RSI(2) chart:
Like RSI(2), ConnorsRSI does not spend a lot of time in the middle of its range. However, we see distinct peaks around 20 to 30 and also 70 to 80. More importantly, we see that there is a lot more variation in the frequency of the 5-point “slices” shown in the chart. Whereas the least frequent slice on the RSI(2) chart occurs about 4% of the time and the most frequent slice occurs less than twice as often at 7.5% of the time, frequencies on the ConnorsRSI chart range from less than 0.5% at the extremes to 3.5% in the mid-range to 8% or more at the peaks. Notably, we observe that ConnorsRSI values below 10 and above 90 are much less likely to occur than their RSI(2) counterparts. The next question is how useful these extreme indicator values are.
The chart below compares the five day returns of ConnorsRSI and RSI(2) for the same slices as the previous chart. In other words, the leftmost green bar shows the average 5-day return for stocks that closed with a ConnorsRSI value between 0 and 5. The leftmost red bar next to it shows the average 5 day return for stocks that closed with an RSI(2) value between 0 and 5.
Here we begin to really see the strength of the ConnorsRSI indicator: extreme values of ConnorsRSI are much more likely to predict a large price move than similar values of RSI(2). In other words, our patience is likely to be rewarded when we wait for the less-frequently occurring extremes in ConnorsRSI.
One final example will help solidify the difference in behavior between ConnorsRSI and RSI(2). The chart below displays price action for SPY in the upper pane, while the lower pane shows corresponding values for ConnorsRSI in blue and RSI(2) in green.
Notice how RSI(2) moves toward the extremes much more often than ConnorsRSI. In fact, any time the indicators move outside the 30-70 mid-range, RSI(2) is generally “leading”, i.e. has a more extreme value. The flip side of this observation is that when ConnorsRSI reaches an extreme value, the stock or ETF is more likely to be in a very overbought or oversold state.
Hopefully these different perspectives on ConnorsRSI will help you develop a better sense of how the indicator generally behaves. By combining this knowledge with historical test results and your own trading experience, you’ll be able to more fully leverage the power of ConnorsRSI.
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