Published on: August 25, 2024
The R3 Strategy is a trading system that Larry Connors and Cesar Alvarez introduced in their book “High Probability ETF Trading.”
Developed in 2003, this strategy is designed specifically for Exchange-Traded Funds (ETFs) and focuses on capturing short-term momentum within a bullish trend. With its unique approach to trading, the R3 Strategy has garnered attention for its simplicity and effectiveness in trading ETFs, which are long-only trades by nature.
Let us get into R3 Strategy, understand its rules, and explore its application through Definedge’s RZone platform.
Understanding the R3 Strategy
The R3 Strategy was developed primarily to focus on trading ETFs and to target a 5-7% momentum trend. The core idea is to identify ETFs that are trending bullishly and have retraced within this bullish trend, providing an optimal entry point for traders.
The strategy aims to capitalise on short-term pullbacks in the ETF price, betting on a continuation of the overall bullish trend. Since ETFs are typically long-only trades, the R3 Strategy is tailored exclusively for bullish setups.
Key Components of the R3 Strategy
The R3 Strategy revolves around a set of well-defined entry and exit rules that leverage the 2-period Relative Strength Index (RSI) as a key indicator for identifying entry and exit points. Here’s a detailed breakdown of these rules:
Entry Rules:
1. The ETF Should Be Above the 200-Day Moving Average (DMA)
This rule ensures that trades are only taken in ETFs that are in a long-term uptrend. The 200-day moving average is a widely recognised indicator of a security’s long-term trend. By ensuring that the ETF is above this level, the strategy filters out ETFs that may be in a downtrend or experiencing significant volatility.
2. The 2-Period RSI Drops Three Days in a Row, and the First Day’s Drop is From Below 60
The 2-period RSI is a short-term momentum oscillator that measures the speed and change of price movements. A drop in RSI for three consecutive days indicates a pullback or minor correction within the overall bullish trend. The condition that the first day’s drop is from below 60 ensures that the pullback is not from an overbought condition, which could indicate a potential trend reversal rather than a continuation.
3. The 2-Period RSI Closes Under 10 Today. Buy on the Close
A 2-period RSI reading below 10 is a signal of extreme short-term oversold conditions. This typically suggests that the ETF has experienced a sharp pullback, providing a potential buying opportunity at a discount. The instruction to buy on the close ensures that the trade is executed at the end of the trading day, capturing the full effect of the day’s price action.
Exit Rules:
The 2-Period RSI Closes Above 70
The exit rule is straightforward: the trade is closed when the 2-period RSI closes above 70. An RSI above 70 indicates overbought conditions, suggesting that the ETF may be due for a pullback or consolidation. Exiting at this point, the strategy locks in profits before a potential reversal.
Implementing the R3 Strategy on Definedge’s RZone Platform
Definedge’s RZone platform offers traders the tools to implement the R3 Strategy easily. The platform’s Entry and Exit Scanners allow traders to quickly identify ETFs that meet the criteria of the R3 Strategy, streamlining the trading process. Here’s a step-by-step guide on how to use the RZone platform to implement the R3 Strategy:
1. Login to RZone with Your Credentials
2. Go to Price Scanner and Select Candlestick Scanner
3. Select “Public” Under Condition and Select “R3 Strategy – Entry”
4. Select Group and Time Frame (Suggest Daily as Per Strategy) and Click on Scan
Following these steps, traders can efficiently identify potential opportunities and execute trades based on the R3 Strategy. Additionally, the platform provides tools for back-testing the strategy, allowing traders to analyse historical performance and fine-tune their approach.
Back-Testing Results for Reference
For those interested in evaluating the performance of the R3 Strategy, back-testing results for “All ETFs (Liquid)” are available on the RZone platform. These results provide valuable insights into the strategy’s effectiveness across different market conditions and can help traders understand the potential risks and rewards associated with the strategy.
To backtest the strategy, follow these steps:
- After login, click on the Menu (left), select Back Testing
- Select Long Only and Public Condition. For Entry, Select “R3 Strategy – Entry” and for Exit, Select “R3 Strategy – Exit”
3. Click on Scan and Back Testing result is here.
Applying the R3 Strategy to Stocks
While the R3 Strategy was originally developed for ETFs, its principles can also be applied to individual stocks for momentum trading. By adjusting the criteria to account for the unique characteristics of stocks, traders can use the R3 Strategy to identify short-term trading opportunities in the stock market.
Conclusion
The R3 Strategy is a powerful tool for traders looking to capitalize on short-term momentum in ETFs. With its clear and concise entry and exit rules, the strategy provides a structured approach to trading that can be easily implemented using platforms like Definedge’s RZone. By focusing on ETFs that are in a bullish trend and have experienced a short-term pullback, the R3 Strategy aims to capture profitable trading opportunities while managing risk effectively.
