Trading Idea #026 – RSI Hann 1

This system, our first of 2022, is based on a John Ehlers’ creation, the RSI with Hann windowing, or RSIH as I will be referring to it here. I will not pretend to understand window functions, but to me it is just another form of smoothing. When RSI is calculated using Wilder’s original calculations, it is choppy. Ehlers has spent decades smoothing, reducing lag, and calculating cycles. The Hann function is interesting, as it was designed by a meteorologist. I love seeing how mathematical functions can be applied over multiple disciplines.

This is what a 13-period RSIH looks like when compared to the regular RSI:

The smoothing feature is very appealing. I find the idea interesting, but I have had little success building systems based on John Ehlers’ works. In this case, I am trying something a little different:

  • When the RSIH changes direction by a certain amount, e.g. .10 points, then enter in that direction;
  • Reverse position when the RSIH changes direction again

One thing that I would like to mention about a difference between RSI and RSIH. Ehlers, like with many of his oscillators, uses 0 as the midpoint, whereas RSI has 50 (or .50, depending on your implementation), -1 as the extreme oversold point (0 for normal RSI), and 1 as the extreme overbought, the same as regular RSI, unless using the 0-100 scale. If I ever meet him, I will ask him why he calculates in this manner.

That is about it for this idea. It is an ‘always in’ system, which is not my favorite type to run due to the capital requirements. I am hoping to catch the occasional fat-tail in the various instruments I select. Let’s see if I can get this work.

Phase 1: Plan & Design

1. Trading Idea

The big idea is to use the RSIH to identify trend direction:

  • 13-period RSIH for direction
  • Long and short entries
  • Weekly timeframe

Here are the entries:

Long:

  • If the RSIH has moved up from the lowest point by .10 or more, then go long next bar at market.

Short:

  • If the RSIH has moved up from the lowest point by .10 or more, then go short next bar at market.

Reverse positions:

  • This is an always-in system, so a short signal will exit a long position, and vice versa.

2. System Definition

Indicator:

RSIH, 13-period

Input Parameters:

Input(Default)Data TypeOptimizable?Comments
Risk_Capital(2500)IntegerYesRisk_Capital
Leverage(4)IntegerYesMultiplier for risk capital

I have considered optimizing for the RSIH Period or the amount the RSIH value must move to trigger a buy or sell signal, but I will keep them as-is. I can consider optimization for future systems.

Variables:

VariableData TypeDefaultCalculation
RSIHDouble0RSI with Hann windowing, as described by John Ehlers (see References at the end of this article)
RSIH_HighDouble0Most recent highest RSIH
RSIH_LowDouble 0Most recent lowest RSIH
NumSharesInteger1Number of shares to buy or sell

Initial Capital:

  • $20,000

Leverage:

  • 4:1

Position Sizing:

  • Risk_Capital = $2,500 per symbol (purchasing power = $10,000)
  • Number of shares = Risk_Capital / Latest Close Price * Leverage (rounded down)

Entry:

  • Long:
    • RSIH >= Lowest RSIH + .1
  • Short:
    • RSIH <= Highest RSIH + .1

Stop:

No stops, only reversals

Exit(s):

  • Exit long position after 1 bar

Profit Target:

  • None

Challenges: None

3. Performance Objectives

The system will meet the following objectives:

ObjectiveGoal
System Type (trend, mean-reversion, day, swing, etc.)Trend
Risk of Ruin0%
Profit Factor> 1.5
Win Percent> 30%
Max Drawdown %< 35%
Profit/Drawdown Ratio> 2.0
Ready Date2022/01/15

The system type was difficult to identify. I think of this as a cross between a swing and trend following system. Our entry is on the swing, but we try to hold as long as possible.

This idea is S.M.A.R.T.: Specific, Measurable, Achievable, Realistic, Time-bound

4. Market Selection

Markets:

EnergiesCurrenciesFixed IncomeAgricultureMetalsSoftsIndexesEquities
X

Instruments:

Market SectorInstrumentSymbolComments
Equities9 select ETF’s
9 select equities
AAPL, GE, GLW, MTZ, PBR, PG, PPG, T, XRX, FEX, IEV, IJR, ITOT, IVV, NOW, QQEW, SPY, XLEI will use a set of 9 ETF’s and 9 stockes that I have utilized in other testing. They all have at least 10 years of data and significant volume over those 10 years to justify their usage here.

Chart Type, Timeframe, Session, Time Zone:

AttributeValueComments
Chart TypeRegular CandlestickCharting is only useful for validating entry and exit signals
Timeframe / Interval(s)Weekly 
SessionRegular 
Time ZoneExchange 

Phase 2: Build

5. Manual Test

Pass.  The instruments I selected seemed to work just fine.

6. Build

Process Diagram

Comments:

This is easy. The only challenging part is holding the highest and lowest RSIH and making sure I manage that variable in the code.

The diagram above is over-simplified, as there is some code that I use to manage the internal variables. Adding these additional processes does not add anything valuable and will just muddle and confuse.

7. Unit Test

I ran into a few bugs during testing. One of the oddities of trading system development is that sometimes your system will appear to work better with the bugs than without. In this case, the system performed better during unit testing with the bug, than it did after fixing it. We should not put too much meaning into this, as it just one instrument and only a unit test.

Complete?

Phase 3: Test

8. Optimization

We are not optimizing any parameters for this system.

9. Walk-Forward Analysis

Rather than build a portfolio, I just tested the instruments one-by-one. Nothing passed, using Profit Factor as my fitness function:

InstrumentTypeProfit Factor
AAPLEquity1.31
GEEquity(0.99)
GLWEquity1.03
MTZEquity(0.90)
PBREquity1.40
PGEquity(0.84)
PPGEquity1.09
TEquity1.14
XRXEquity(0.64)
FEXETF(0.82)
IEVETF(0.73)
IJRETF1.26
ITOTETF(0.86)
IVVETF(0.78)
NOWETF1.17
QQEWETF1.14
SPYETF(0.82)
XLEETF1.13

The only thing I can say is that there are too many entries with this system. At this point, the system fails, so we will move to our notes and commentary.

10. Monte Carlo Simulation

We did not make it this far.

11. Incubation

We did not make it this far.

Phase 4: Deploy

12. Production / Portfolio Assignment

We did not make it this far.

Trading System Result: FAIL

Notes and Commentary

The system failed, but there were some things that I liked. The entries looked okay, even with the lag. I think having any system as an always-in type is that there are times when we should just stay in the market and times to sit and wait for the next opportunity.  There were some fat tails (big wins), but there were too many losses along the way the nibbled away at the fat tail profit that nullified the advantage.

I believe that the RSIH has as much utility as any other RSI. The RSIH has the smoothing, which simplifies analysis at the cost of lag.

Continuous Improvement Department:

Overall, this system idea is okay, but not worth it. Here are some thoughts about what I can do with what I learned:

  • Step away from the quick exit and try longer holding periods
  • Filter for symbols with only a positive earnings-per-share (EPS)

Next Trading System Idea: RSIH with Fractals

I really enjoyed working with this indicator, despite the failure. I tried using some additional filters to improve the exit signals. Next time, I will add Bill Williams Fractals for exits (or pivots, if you prefer), to see if this improves the exits, profitability, and drawdowns. Until then, thank you for reading and trade well!

Do you have a trading idea that you want me to put through our process to see if it would make a valid trading system?  Leave a comment below and we can discuss.

Sources/References

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