This Simple System Beat the Market 85% of the Time
By -Edward Lance Lorilla
August 21, 20247 minute read
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Here's why we gave it out for free…
August 21, 2024
This Simple System Beat the Market 85% of the Time
BY Keith Kaplan CEO, TradeSmith
As investors, uncertainty is our constant companion.
Nobody can predict the future. So, no matter how confident we may be, we can never be certain of the outcome for any investment.
We can only optimistically assume that, when the time comes to cash out, we'll get back more money than we put in... or at least break even.
And while we wait, we all have that little voice in the back of our head pop up and say, "I hope I didn't make the wrong decision...
"Or make the right decision too early...
"Or too late."
Here at TradeSmith we dedicate all of our time, energy, and money into raising your odds of investment success. A big part of that success is simply owning the right stocks... at the right time.
And because of the team we've carefully curated, a day doesn't go by in these offices without one of our brilliant analysts coming up with an idea to test in this regard.
In fact, we just got the results of one such idea from the TradeSmith Research Lab. It's so deceivingly simple, but so provably effective, I want to share it with you today.
At its core, it shows you the right time to buy... and when to sell... any asset we track in our system.
But it works especially well on high-quality companies.
Let me show you...
The RSI Precision Strategy
You may be familiar with the Relative Strength Index (RSI). This is a technical indicator, used on stock charts, which shows the relative buying or selling pressure in an asset compared to its recent trading history.
Here it is at the bottom of a chart of the S&P 500 going back to the start of 2023:
The 70 and 30 levels on the RSI are key. When the RSI rises through 70, the asset in question is considered overbought and prone to correction. When it hits 30 or below, it's oversold and due for a bounce.
You can see that, since 2023:
The S&P 500 has gone overbought (red line) far more than it's gone oversold (green line).
Most recently, it crossed into overbought territory in the first half of June. But it didn't stop there. It kept running higher along with the RSI, which peaked at about 82 before stocks began to correct.
The steepest oversold conditions above were between late September and late October 2023 when the RSI crossed below 30 – which proved to be an unmissable buying opportunity.
We've observed these tendencies in the RSI for a long time. But it was only recently that we asked ourselves: "What if you built an entire investment strategy that used the RSI as buy and sell signals?"
Normally, proving out something like this is tedious and difficult. You'd have to go back and plot every time an asset has hit the upper and lower bounds of the RSI for as long as it's been trading, and then calculate the forward performance and compare it to the market.
But thanks to our analytical firepower and brain trust of researchers, we were able to put together this study in a matter of days. Here's how it went:
We took a basket of high-quality stocks that have been turning in positive earnings before interest, taxes, depreciation, and amortization (EBITDA), with a history of positive earnings and revenue surprises as well...
Merck (MRK), Meritage Homes (MTH), International Paper (IP), and Discover Financial (DFS) all made the cut, to name a few examples.
Then we set up a strategy to buy and sell each stock when its RSI level got too extreme.
Specifically, we'd buy the day after they hit 30 on the RSI, watch for them to cross all the way up through 80, then sell the day after they fell back through 70 on the RSI. (That's because, as you see above, overbought conditions tend to stay overbought for quite a while – and get more extreme – before reverting.)
This strategy would go back as long as each stock has trading data.
And it worked 100% of the time for many of the stocks. For example:
IP went 10-for-10 with this strategy, averaging 42.8% gains in about 2 years.
DFS went 7-for-7, averaging 22.5% gains in 9 months.
MRK went 6-for-6, averaging 18.3% gains in 10 months.
And MTH also went 10-for-10, averaging 71.9% gains in about 6 months!
Now how would you guess the strategy did overall?
I figured it would do well, and probably beat the market.
But I was blown away at just how statistically strong this strategy is.
Using this strategy on our basket of high-quality stocks would've resulted in 1,540 total trades. Of those, 1,457 were profitable, a win rate of 94%.
And those winning trades beat the S&P 500's performance 85% of the time.
This is a huge edge for investors. Like many of our other tools at TradeSmith, it takes so much of the uncertainty out of your investing plan.
Great stocks can be hard to part with. So, instead of ignoring the warning signs in stocks you own because you're too busy celebrating the profits, you'll know when to clear some chips from the table.
Then, instead of wondering the best time to buy back in, you'll know exactly the level to hunt for deals.
Now, this is all great theory. We should buy high-quality, oversold stocks and sell overbought ones.
But we know that making this strategy easy to use is just as important as confirming it works.
And that's where our expertise as a software company come into play...
Turning Theory Into Action
We didn't just set out to prove that this strategy works. We want it to be easy for TradeSmith users to start using.
Currently, any TradeSmith Finance user can type in a stock ticker, pull up its chart, and check for opportunities where that stock has crossed below 30 on the RSI (a buy signal) or above 80 (a sell signal).
But now, we're adding two new features to make this strategy easy to implement:
More than 62,000 TradeStops users will soon be able to set custom alerts and be notified by email when a stock they own crosses below 30, above 80, or any other RSI level of their choosing.
And for our Platinum users – who've committed to our highest-tier lifetime membership and get everything we publish and create – we've added an exclusive new screener that immediately finds high-quality stocks (as we've described above) with an RSI below 30. Here's what that looks like, with the top 10 stocks as of Monday, Aug. 19, sorted by market capitalization:
We hope our Platinum users take a regular look at this screen to find the rare oversold stocks, then dig deeper to see if the company is cheap and high-quality enough to warrant a buy.
And for all our TradeStops users, our hope is that these overbought and oversold signals help you make the right moves at the right time – whether it's to lock in wins or buy stocks when the crowd is rushing for the exits.
And I should add, the alerts feature is being added 100% for free, even for non-Platinum users. If you own a TradeStops product, you get it.
Why? Because if we can easily solve such a big problem that so many investors face, and can put this tool into their arsenal with the simple quick of a button... I say we go for it.
There's more to come for our TradeSmith users from our Research Lab, so stay tuned...
