Dan FitzpatrickIf Anybody Cares....12/27/2006 12:50 PM EST
RSI and stochastics measure the same thing -- momentum -- only their calculations are different. RSI is a "closed" indicator -- the amount of historical data is fixed, and the most recent data is added while the oldest data drops off the back end. (The "moving average" concept.) The general direction of RSI indicates the existence of an uptrend or downtrend. The distance away from the midline indicates the strength of that uptrend (above the midline) or downtrend (below the midline).
RSI is based on the idea that an advancing stock will tend to close nearer the high of the day, and will often close higher than yesterday's close. An advancing stock will also tend to advance more on "up" days than it will decline on "down" days. Put another way, an advancing stock tends to take big steps when moving forward, but just baby steps when backing up. RSI parses the data by differentiating between "up" days and "down" days.
RSI is used as both a momentum indicator and as a measure of overbought/oversold. These terms are different. Momentum simply refers to whether a particular price move is picking up steam or starting to stumble -- that is, momentum can be increasing in either an upward or downward direction. "Overbought/Oversold" are terms for price extremes within trading ranges. If you are walking your dog, momentum refers to the speed and direction of travel. The extremes of overbought and oversold refer to how hard the dog is straining at the leash. The stronger the pull, the greater the extreme overbought or oversold condition. Note that, when RSI begins moving the other way, it indicates that the dog is tiring and is not pulling so hard. You and the dog are still moving in the same direction, but the leash isn't as tight.
Like all bounded oscillators, RSI works best in a trading range. When a stock is bouncing up and down within a defined channel, RSI is quite useful in comparing the peaks and valleys. However, it has limited utility during a trend. Simply put, the most bullish thing a stock can do is become overbought. The most bearish thing a stock can do is become oversold.
Similarly, stochastics also measure the price velocity of a stock or index. Stochastics, like RSI, is a closed indicator that shows us where the price is trading within a given range. The shorter the stochastics period (as opposed to the chart period), the more signals given. The "signals" provided by stochastics are when the signal line turns up or down through the moving average of that signal line. It is, essentially, a moving average crossover methodology. Stochastics parses the data a bit differently than RSI. Instead of categorizing according to "up" or "down" days, stochastics measures the current closing price according to its location within the high-low price range of the period in question.
You can see that, while the calculations are a bit different, RSI and stochastics are indicators that, well, indicate the same thing. Even their recommended periods are the same -- 14.
Using stochastics and RSI together creates a multicollinearity issue -- a topic that I covered in depth a couple of years ago at a seminar sponsored by TheStreet, along with Helene Meisler, Gary Smith and Dick Arms. Of course, opinions always vary -- which is why Baskin-Robbins has 31 flavors of ice cream in its stores. But it would be missing the mark to tacitly believe that these indicators work equally well in any kind of price environment. They do not. For example, David Steckler, a well-known market technician, refined the "Stochastics Pop" technique originated by Jake Bernstein into what he calls the "Popsteckle". Both strategies are based on the principle that very dynamic and tradeable moves occur when a stock breaks out and is accompanied by a stochastic indicator that goes over 70. The "pop" refers to the price breakout, not stochastics. The "overbought" stochastics merely confirm the upside breakout of price. The trade is to buy the overbought reading, not sell it. Again, these indicators work completely differently when analyzing stocks in consolidation versus trending stocks.
I had the pleasure of working with John Bollinger for a while after I first returned to the West Coast from New York. That was right after he published a very thoughtful and practical book entitled "Bollinger on Bollinger Bands". John covered the topic of multicollinearity (i.e., using different indicators that measure the same thing to give you a warm and fuzzy feeling) in his book and we used to talk about it all the time. I recommend the book to anyone who is interested in learning more on the subject. It is an important one that helps separate heat from light.
I am going out to return all the socks and neckties I got from my nieces and nephews for Christmas. Have a good day. Position: Now more than ever ... be careful out there.</SPAN>
RSI is based on the idea that an advancing stock will tend to close nearer the high of the day, and will often close higher than yesterday's close. An advancing stock will also tend to advance more on "up" days than it will decline on "down" days. Put another way, an advancing stock tends to take big steps when moving forward, but just baby steps when backing up. RSI parses the data by differentiating between "up" days and "down" days.
RSI is used as both a momentum indicator and as a measure of overbought/oversold. These terms are different. Momentum simply refers to whether a particular price move is picking up steam or starting to stumble -- that is, momentum can be increasing in either an upward or downward direction. "Overbought/Oversold" are terms for price extremes within trading ranges. If you are walking your dog, momentum refers to the speed and direction of travel. The extremes of overbought and oversold refer to how hard the dog is straining at the leash. The stronger the pull, the greater the extreme overbought or oversold condition. Note that, when RSI begins moving the other way, it indicates that the dog is tiring and is not pulling so hard. You and the dog are still moving in the same direction, but the leash isn't as tight.
Like all bounded oscillators, RSI works best in a trading range. When a stock is bouncing up and down within a defined channel, RSI is quite useful in comparing the peaks and valleys. However, it has limited utility during a trend. Simply put, the most bullish thing a stock can do is become overbought. The most bearish thing a stock can do is become oversold.
Similarly, stochastics also measure the price velocity of a stock or index. Stochastics, like RSI, is a closed indicator that shows us where the price is trading within a given range. The shorter the stochastics period (as opposed to the chart period), the more signals given. The "signals" provided by stochastics are when the signal line turns up or down through the moving average of that signal line. It is, essentially, a moving average crossover methodology. Stochastics parses the data a bit differently than RSI. Instead of categorizing according to "up" or "down" days, stochastics measures the current closing price according to its location within the high-low price range of the period in question.
You can see that, while the calculations are a bit different, RSI and stochastics are indicators that, well, indicate the same thing. Even their recommended periods are the same -- 14.
Using stochastics and RSI together creates a multicollinearity issue -- a topic that I covered in depth a couple of years ago at a seminar sponsored by TheStreet, along with Helene Meisler, Gary Smith and Dick Arms. Of course, opinions always vary -- which is why Baskin-Robbins has 31 flavors of ice cream in its stores. But it would be missing the mark to tacitly believe that these indicators work equally well in any kind of price environment. They do not. For example, David Steckler, a well-known market technician, refined the "Stochastics Pop" technique originated by Jake Bernstein into what he calls the "Popsteckle". Both strategies are based on the principle that very dynamic and tradeable moves occur when a stock breaks out and is accompanied by a stochastic indicator that goes over 70. The "pop" refers to the price breakout, not stochastics. The "overbought" stochastics merely confirm the upside breakout of price. The trade is to buy the overbought reading, not sell it. Again, these indicators work completely differently when analyzing stocks in consolidation versus trending stocks.
I had the pleasure of working with John Bollinger for a while after I first returned to the West Coast from New York. That was right after he published a very thoughtful and practical book entitled "Bollinger on Bollinger Bands". John covered the topic of multicollinearity (i.e., using different indicators that measure the same thing to give you a warm and fuzzy feeling) in his book and we used to talk about it all the time. I recommend the book to anyone who is interested in learning more on the subject. It is an important one that helps separate heat from light.
I am going out to return all the socks and neckties I got from my nieces and nephews for Christmas. Have a good day. Position: Now more than ever ... be careful out there.</SPAN>
