Tuesday, June 12, 2012

Wilders' RSI versus Stochastic

MetaStock SPRS Series - Week 72 - TechniTrader® Stock Discussion for MetaStock Users - Wilders' RSI versus Stochastic - June 11, 2012
By: Martha Stokes C.M.T.

Hi Everyone,

Stochastic is the most popular of all of the price oscillators available for stock chart analysis. In my last MetaStock Sponsored Webinar I talked about setting up your indicators for your own personal trading style and trading parameters. Being as specialized and proprietary as you can possibly be with your own unique set of trading indicators is a huge plus and gives you a decided edge against the pros in the market.

Using an indicator that is overly popular can be detrimental to your success as a trader. It can be hard to switch to a lesser known indicator because most traders want to be part of the crowd. But being part of the retail crowd means you are constantly at higher risk of whipsaw trades as cluster orders are constantly being tracked by the High Frequency Trading Firms.

Wilder’s RSI is not widely used these days and has the added feature of being highly adaptable and modified. Below is how I set RSI up for my TechniTrader® Students.

Chart 1

As with volume oscillators, a center line oscillation feature for RSI adds depth to the analysis. Instead of looking at merely overbought oversold patterns highs and lows, when the RSI starts to waver around its center line it exposes the bottoming pattern of this stock before it gaps up.

Stochastic as it is traditionally used strictly for overbought and oversold, is not exposing the bottoming action underway. The oscillation actually causes whipsaw risks during this bottoming phase.

Using RSI to expose the strength of the bottom via a center line that floats with price direction, tells you far more about the strength of the sideways pattern and the decided upside direction, even though price is still sideways.

In addition RSI is a very different formula compared to Stochastic. Wilder wrote it to expose whether the current price was stronger or weaker than “X period” or number of days ago. Therefore what you are looking at is a Relative Strength relationship between the current price and “x number of periods” aka days ago.

RSI therefore can and does expose strengthening price action to the upside or downside in a sideways pattern. This is a huge benefit for traders because the markets move sideways about 60% of the time.

Although Stochastic is great for exposing the overbought /oversold aspects of a sideways pattern, what is even more important is to be able to anticipate what direction the stock will move, and how fast it will move out of a sideway pattern.

RSI is superior in revealing strengthening price action, which in turn exposes momentum prior to gaps and fast runs.

Try using RSI as the market begins to bottom after this correction. It is a very underrated indicator that traders can use to see momentum building prior to huge price gains.

Trade wisely,

Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
MetaStock Partner

©2012 Decisions Unlimited, Inc.

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