What is Laguerre RSI?
Laguerre RSI improves on the responsiveness of regular RSI, while it minimizes whipsaw trading. However, before we discuss Laguerre RSI, we should look at the Relative Strength Index (RSI).
I have tried to minimize the use of formulas and focus primarily on why the Relative Strength Index and the Laguerre RSI tools used and the relative strengths of each of them. Both show whether a security is oversold or overbought, so market makers can make better buying and selling decisions.
Relative Strength Index (RSI)
The RSI, authored by Wells Wilder, is used during technical analysis to measure the size of price changes in order to analyze whether stocks or other assets have been oversold or overbought on a line graph between 0 and 100.
When RSI shows that values above 70, this indicates that a security might be overvalued or overbought and a pullback or reversal could be coming, if it is 30 or below, the asset could be undervalued or oversold.
The formula for the RSI is a two-part calculation and it begins with this formula:
RSI_{\text{step one}} = 100- \left[ \frac{100}{ 1 + \frac{\text{Average gain}}{\text{Average loss} }} \right]RSIstep one=100−[1+Average lossAverage gain100]
This formula uses the average loss or gain during a look-back period. Fourteen periods (14 days) are used to calculate the beginning RSI value.
After the 14 data periods are used, the second part of the RSI formula is calculated to smooth the calculation as follows:
RSI_{\text{step two}} = 100 - \left [ \frac{ 100 }{ 1 + \frac{ \left ( \text{Previous Average Gain} \times 13 \right ) \ + \ \text{Current Gain} }{ \left ( \left ( \text{Previous Average Loss} \times 13 \right ) \ + \ \text{Current Loss} \right ) } } \right ]RSIstep two=100−[1+((Previous Average Loss×13) + Current Loss)(Previous Average Gain×13) + Current Gain100]
The RSI increases as the size and number of the positive closes rising and falling as the size and number of the losses increases.
As the RSI exceeds 30, it is a bullish sign and below 70, it is a bearish sign.
The RSI technical indicator is most reliable when its signals comfort to long term trends.
False signals, although rare, can occur.
These signals indicate momentum, and this tool is mostly useful in a market where the assets are alternating between bearish and bullish.
Laguerre RSI differs from Regular RSI
Laguerre RSI was introduced by John Ehler and his model when applied to trading, removes the problem of delay in trading signals indicators with a long period as it filters off random swings and price swings.
It uncovers short term pullbacks for greater protection. When buying and selling stocks, you should seek an indicator that would quickly respond to price changes, so you have the least number of false signals and Laguerre RSI is designed to reduce the noise and the lag in regular RSI.
Laguerre RSI is like the regular 4 period RSI, with the ability to be applied to price smoothing. Laguerre RSI provides smooth indicators to be created with small data amounts.
The smoothing minimalizes the choppiness found in the regular RSI predecessor and while Laguerre is smoother, it gets a good job of capturing the larger price moves.
Hence, Laguerre RSI provides a fast-reacting RSI without losing reliability.
In Mr. Ehlers’ “Time Warp – Without Space Travel” paper, he tried to address the frustrating problems in avoiding whipsaw trades. He looked for a way to achieve a balance the amount of smoothing needed and extent that lags should be tolerated.
John Ehlers asserted that using a moving average could help solve this problem and he suggested using this equation for the moving average. Successively older samples of data from the newest samples should be averaged to obtain that filtered output.
Filter = (Price + Price [1] +Price [2] + Price [3])/4
Mr. Ehlers suggested that if the two middle samples were used, they should have double the weight as the newest sample in a 4-sample example.
That equation for the filter would be:
Filter = (Price +2*Price[1] = 2*Price[2] + Price [3])/6
John Ehler said that his model gives a time warp, so that low frequency portions of the price are delayed considerably more than the high frequency portions, and this allows for smoothing filters to be created using this time warp.
Hence, only a few data samples are made using this time war and since only a few data samples are used, they will be much more responsive to recent price data. This increased responsiveness means quicker reaction time when making trades, so profitability improves because of a reduced signal lag.
You might be interested in the Time Warp Trading System here.
Further analysis, shows that the larger the gamma and the smoother Laguerre becomes and like regular RSI, Laguerre RSI is used for countertrend and trend strategies.
Laguerre RSI like regular RSI should be used with other trend detection indicators. This can be done by trading in the longer-term trend’s direction, but using the Laguerre version to look for pullbacks.
For trend detection, use Laguerre RSI for 50 periods, while for pullback detention, use the 30/70 thresholds just like in regular RSI. However, Laguerre RSI is responsive and it can show 0.15 and 0.85 for the oversold and overbought thresholds.
Regular RSI is not as complex as Laguerre RSI. The Laguerre version improves responsiveness and reliability. Both versions are wonderful for discovering oversold and overbought conditions, and both can be used for pullback filtering trend strategies.
Laguerre RSI is traded in a manner similar to RSI.
You would buy when the value slips below a critical point and the trade when it reaches above a threshold and sell when the value is reversed.
In my reading, that on the DOW, Laguerre RSI produces somewhat better outcomes than RSI. When trading on the NASDAQ, the Laguerre RSI does much better. However, net profit and the annual rate of return is very close when comparing the RSI and the Laguerre trading models.
You might also want to check out What is an RSI Divergence indicator on thinkorswim? and What is Supertrend on Thinkorswim?
