V.11:5 (189-199): Stochastic RSI And Dynamic Momentum Index by Tushar Chande and Stanley Kroll

Item# \V11\C05\STOCHAS.PDF
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Stochastic RSI And Dynamic Momentum Index by Tushar Chande and Stanley Kroll

Here, a relative strength index (RSI) tutorial clarifies the basics of the time-honored indicator. The tutorial also introduces new variants that STOCKS & COMMODITIES contributor Tushar Chande and Kroll, Chande & Co.'s Stanley Kroll call net momentum oscillator and the stochastic RSI, which are better at flagging overbought and oversold conditions than RSI itself. Also introduced and examined is a variable-length RSI called the dynamic momentum index (DMI), which we indexed to market volatility. The new variants, Chande explains, extend the scope and power of momentum indices, as we will see.

Many articles in STOCKS & COMMODITIES have described J. Welles Wilder's relative strength index (RSI) and its derivatives. One recent example was the relative momentum index (RMI), which was discussed by Roger Altman. In another, William Blau wrote about the true strength index (TSI), a double-smoothed version of RSI that is identical to the RSI except for a scaling constant. Each RSI derivative is a valuable extension of the approach. However, details of RSI development were not shown in either derivation, and thus, it is sometimes difficult to determine what RSI and its derivatives are measuring. They are, of course, measuring momentum. But that is only part of the story.

We will take a tutorial look at RSI and its derivatives, then break down RSI and reassemble it so we know how it works. After that we will do the same with the derivatives. First, we will discuss a net momentum oscillator and a stochastic RSI, which are better at flagging extremes in prices than RSI. Then we will index the RSI to price volatility. This leads to a variable-length dynamic momentum index (DMI) that automatically adjusts to market action. The new RSI variants extend the scope and power of momentum indices.

THE BASICS OF MOMENTUM

In technical analysis, we define momentum as the difference between two prices. The time period between the two prices varies. The two prices can be as little as one period apart, while the period can be any time length from minutes to months. Most commonly, we use one trading day as the unit of time. With a one day time period, the closing prices (C) define momentum as shown here.

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