Momentum Indicators (16 lessons)
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5 Key Differences between the Stochastic RSI and Stochastic

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Momentum based indicators are one of the most popular tools when it comes to technical analysis. While there are many different momentum based indicators, the RSI and the Stochastics oscillators are two of the most commonly used technical indicators. Both the indicators are used to measure momentum of prices and were developed early on when technical analysis was still evolving. Momentum based indicators or oscillators are often used to compliment a trend trading strategy as the rising and falling momentum, signaled by the indicator can show turning points in prices, or to put it differently, momentum based indicator, when used in conjunction with trends can signal the dips and rallies in an uptrend and a downtrend respectively.

Although both the Stochastics and the RSI measure momentum, the way momentum is measured is quite different in both the indicators, making both these indicators unique. A more recent addition to the momentum family of indicators has been the Stochastics RSI which takes a different twist to measuring momentum. Both the indicators were developed two very well known names in technical analysis, George Lance and Welles Wilder.

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While it is easy to see the similarity between the Stochastics and the Stochastics RSI, both these indicators are actually quite different in the way the measure momentum. However when you apply both the indicators side by side, visually both the indicators look almost similar having the %K and the %D lines on the oscillator.

In order to better understand the difference between the Stochastic RSI and the Stochastics oscillator, we need to know in detail how each of these two indicators work.

What is the Stochastics oscillator?

The Stochastics oscillator or Stochs for short is a typical range bound oscillator measuring price momentum. As with many other indicators that fall under the same category, the Stochastics oscillator displays the location of the closing price compared to the high and low range that was established over a specified (user defined) period of time. The Stochastics oscillator’s main purpose is to look for overbought and oversold levels which signifies rising and falling momentum and most applicable during trends or during range bound markets. The Stochastics oscillator is also used as a divergence indicator.

The Stochastics oscillator was developed by George Lane in the 50’s and according to Lane, the Stochastics oscillator was a credible way to measure price momentum. More importantly, Lane believe that changes in momentum often preceded changes in price, in a way making the Stochastics oscillator a type of a leading indicator for price changes by measuring momentum. Lane attributed this theory by comparing the way a rocket lifts off. Lane was famously quoted as saying that before a Rocket can change direction and turn down; the rocker’s momentum needs to slow. Similarly when price changes, momentum needs to slow, which is indicated by the Stochastics oscillator.

The Stochastics oscillator can be used in both range bound markets as well as trending markets due to its fixed movement between 0 and 100. The Stochastics oscillator is comprised of the first line known as %K which displays the current closing prices in relation to the defined high and low period. The second line known as %D is a simple moving average of the %K. There are many different settings for the Stochastics oscillator but the most common settings is the 14, 3, 3 or simply 14, 3, which indicates a 14-period look-back and a 3 period SMA for %K, which is %D.

The chart below shows the typical Stochastics set up for a price chart.

Example Stochastics indicator with 14, 3, 3, Set up

Example Stochastics indicator with 14, 3, 3, Set up

Besides the 14, 3 or the 14, 3, 3 setting of the Stochastics oscillator, there are other versions such as the full Stochastics and the slow Stochastics, which is nothing but different parameter settings. The slow Stochastics is less sensitive to momentum but shows a much smoother output and is usually used to determine the long term trends. On the other hand, the fast Stochastics are more sensitive to price momentum and can signal short term changes in momentum of prices.

The most common way to trade the Stochastics is to make use of closing prices, based ff which the momentum is determined. For example, if price closed in the upper half of the range that was established from the past 14 period’s high and low, then this is reflected by the %K line rising. This also signals increased momentum and thus more buying pressure in the market. Similarly, when price closes in the lower half of the range of the past 14 periods, then the %K line falls or slopes down, indicating weakening momentum or increase selling pressure. When this information is used on conjunction with the trend, it can provide buying or selling opportunities.

The next chart below shows a few examples of how the Stochastics %K line (and thus %D) rise and fall in relation to closing prices, depicted by the line chart.

Stochastics %K and %D lines indicating rising and falling momentum

Stochastics %K and %D lines indicating rising and falling momentum

The %D is the simple moving average of the %K and similar to the general rules of moving averages, when the %K cuts across the %D line, buy and sell signals are generated or the momentum is seen to increase and decrease even further.

What is the Stochastic RSI oscillator?

The Stocahstic RSI indicator or Stoch RSI is an advanced version of the Stochastics oscillator. The primary difference being that the Stochastics RSI indicator is known as an indicator of an indicator. The Stoch RSI was developed by Tushar Chande and Stanley Kroll and the indicator was introduced in 1994 in a book called The New Technical Trader.

Stochastics RSI Oscillator

Stochastics RSI Oscillator

The Stochastics RSI indicator is used in technical analysis and provides a stochastic calculation of the RSI (Relative Strength Index) which is another momentum based indicator. The main difference here being that, the Stochastics RSI measures the RSI, relative to its RSI’s high and low range over the specified period of time.

You can see by now the following relationship.

  • RSI indicator is based on price
  • The Stochastic RSI is based on RSI

Thus, the Stochastic RSI is basically two steps away from price. As with all momentum indicators, the Stochastic RSI indicator oscillates between fixed values, but that is 0 and 1 in this instance. The Stochastic RSI is used to identify overbought and oversold levels in the markets.

The basic premise behind developing the Stochastic RSI oscillator, outlined in the book, The New Technical Trader is that the RSI oscillator is able to oscillate between the overbought and oversold values of 80 and 20 for extended periods of time without reaching the extreme levels of 100 and 0. Generally, the RSI oscillator has the overbought and oversold values at 70 and 30. Traders look to enter a trade when the RSI is oversold and exit or trim their positions when the RSI is overbought. But when the RSI starts to move within the bands traders are often left on the sidelines.

In order to address this issue, Chande and Kroll designed the Stochastics RSI to increase sensitivity to the RSI and generate more overbought and oversold signals. However, due to the fact that the StochasticRSI is an indicator of an indicator, there can be a significant lag between the signals generated by the indicator and the actual price chart. Furthermore, the Stochastics RSI can be very choppy when the markets are range bound and the overbought and oversold signals can lead to many false signals.

Similar to the Stochastics oscillator, the Stochastics RSI also comes with similar parameters in addition to the RSI setting. Therefore the values are generally, 14 periods RSI, 14 period look back of the RSI and 3 period SMA. It is commonly referred to as the 14, 14, 3, 3 setting.

When trading with the Stocahstics RSI, there are some key factors to bear in mind.

Firstly, the Stochastics RSI measures the value of RSI, relative to the high and low range of the RSI from the user defined look back period.

Secondly, the number of periods used to calculate the Stochastics RSI is entered directly into the StochRSI settings. Example, if you used a value of 14 for the RSI, then the look back period of the high and low range of the RSI is 14 periods.

Finally, there are some key values from the Stochastics RSI oscillator.

  • RSI is at the lowest point when 14-day Stochastic RSI = 0
  • RSI is at the highest point when 14-day Stochastics RSI = 1
  • RSI is at the middle when 14-day Stochastics RSI = 0.5
  • RSI is near the low point when 14-day Stochastics = 0.2
  • RSI is near the high when 14-day Stochastics = 0.8

Interpretation of the Stochastics RSI Oscillator

Overbought and oversold levels: A Stochastic RSI reading above 0.80 is considered to be overbought, while the indicator reading below 0.20 is considered to be oversold.

Trends: When the Stochastics RSI oscillator is consistently above 0.50, it reflects an uptrend in prices and when the Stochastics RSI oscillator is consistently below 0.50, it reflects a downtrend in prices

An important point to remember about the Stochastic RSI is that the original indicator did not have the SMA of the %K. However more and more technical charting platforms have started offering the SMA setting of the %K as well making it look similar to the regular Stochastics oscillator.

Most of the charting platforms also have the Stochastics RSI indicator to use the values of 0 – 100 instead of the original 0 and 1.

Stochastic RSI Indicator showing Overbought and Oversold signals

Stochastic RSI Indicator showing Overbought and Oversold signals

The above chart shows the Stochastics RSI indicator without the %D or the SMA of the %K. Here the 80 and 20 values are used instead of 0.8 and 0.2. Still, whenever the Stochastics RSI rises from above 0.20, in most cases you can find price rallying and similarly falling prices when the Stochastics RSI falls from 80 level.

Five key differences between the Stochastic RSI and Stochastic

Now that we know how the Stochastic RSI and the stochastic oscillator works, here are the five key differences between the two oscillators.

  1. The Stochastics oscillator measures price momentum and is based on the closing price relative to the user defined high and low range from the look back period. The Stochastic RSI on the other hand measures the momentum of the RSI and is based on the closing price of RSI, relative to the user defined high and low range from the RSI’s look back period.
  2. The Stochastics oscillator is based directly from price, whereas the Stochastics RSI is an indicator of an indicator meaning that it measures the momentum of the RSI, which is based on price. In other words, the Stochastics RSI is simply two steps away from price and can therefore lag significantly
  3. The regular Stochastics oscillator moves between fixed values of 0 and 100 with 80 indicating overbought level and 20 indicating oversold levels. The Stochastic RSI on the other hand oscillates between 0 and 1 where 0.80 indicates overbought levels and 0.20 indicates oversold levels
  4. Unlike the Stochastics oscillator, the Stochastic RSI also has a mid level of 0.50 which is used as a trend filter. Therefore, if the Stochastic RSI continually plots above 0.50, the market is set to be in an uptrend and when the Stochastics RSI plot below 0.50, the market is set to be in a downtrend. Most charting platforms now generally use the Stochastics RSI values to oscillate between 0 and 100 instead of the original 0 and 1 values.
  5. While the Stochastics oscillator is used to measure price momentum and overbought/oversold levels, the Stochastics RSI is designed to be more sensitive and triggers a lot more overbought and oversold levels in comparison to the traditional Stochastics oscillator.

The chart below shows a comparison between the Stochastics oscillator and the Stochastics RSI. You can see how the Stochastics RSI triggers more overbought and oversold levels compared to the traditional Stochastics indicator.

Stochastics vs. Stochastics RSI indicator

Stochastics vs. Stochastics RSI indicator

In conclusion, the Stochastics RSI is one of the many different technical indicators used to determine momentum. As with any technical analysis approach, the Stochastics RSI indicator is best used to determine over bought and oversold levels, especially in ranging markets. The indicator can also be used alongside the regular Stochastics oscillator as well.

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