Relative Strength Index vs. Stochastic Oscillator: An Overview
The relative strength index (RSI) and the stochastic oscillator are price momentum oscillators used to forecast market trends. The two indicators have very different underlying theories and methods despite their similar objectives.
The stochastic oscillator is predicated on the assumption that closing prices should close in the same general direction as the current trend. RSI tracks overbought and oversold levels by measuring the velocity of price movements. More analysts use RSI over the stochastic oscillator but both are well-known and reputable technical indicators.
Key Takeaways
- RSI and stochastics are both momentum oscillators but there are notable differences between the two indicators.
- Created by J. Welles Wilder, RSI measures recent gains against recent losses.
- Stochastic oscillators or stochastics are based on the idea that closing prices should confirm the trend.
- Both RSI and stochastics are used as overbought/oversold indicators.
- High readings suggest an overbought market and low readings are indicative of oversold conditions.
Relative Strength Index
J. Welles Wilder Jr. developed the relative strength index (RSI) by comparing recent gains in a market to recent losses. RSI is a momentum indicator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset.
RSI is typically displayed as an oscillator. A line graph moves between two extremes along the bottom of a chart and can have a reading from 0 to 100. The midpoint for the line is 50. The underlying asset is considered to be overbought when RSI moves above 70. The asset is considered oversold when the RSI reads below 30.
Traders also use the RSI to identify areas of support and resistance, to spot divergences for possible reversals, and to confirm the signals from other indicators.
Stochastic Oscillators
George Lane created stochastic oscillators. They compare the closing priceof a security to a range of its prices over a certain period. Lane believed that prices tend to close near their highs in up-trending markets and near their lows in down-trending ones.
Like RSI, stochastic values are plotted in a range between 0 and 100. Overbought conditions exist when the oscillator is above 80. The asset is considered oversold when values are below 20.
Stochastic oscillator charting generally consists of two lines. One reflects the actual value of the oscillator for each session and one reflects its three-day simple moving average. Price is thought to followmomentum so the intersection of these two lines is considered to be a signal that a reversal may be in the works. It indicates a large shift in momentum from one day to the next.
Divergences between the stochastic oscillator and trending price action are seen as an important reversal signal. It may be an indicator that bears are exhausting their momentum and that a bullish reversal is brewing when a bearish trend reaches a new lower low but the oscillator prints a higher low, Divergences between RSI and price are considered significant as well.
When Is a Stock's Closing Price Reported?
A stock's closing price is the last price at which it traded during a regular trading session that generally runs from 9:30 a.m. to 4:00 p.m. ET, not including weekends and holidays. The regular trading session closing price for stocks is therefore 4:00 p.m. It's usually made available to traders within 30 seconds to 30 minutes after the closing bell.
What Are Some Disadvantages of the Stochastic Oscillator?
The Stochastic Oscillator can and often does produce false signals. This can be accommodated by confirming all signals rather than blindly accepting them. Keep in mind that stochastics are more reliable when the market is trending.
What Are Some Disadvantages of Relative Strength Index?
RSI can also generate false signals. Sudden and extreme price movements can make it spike and produce misinformation. It can also stall for significant periods without indicating a trend. It may not be particularly helpful during strong trends.
The Bottom Line
Relative strength index was designed to measure the speed of price movements. The stochastic oscillator formula works best when the market is trading in consistent ranges. RSI is generally more useful in trending markets and stochastics are more useful in sideways or choppy markets.
