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STOCHASTICS

Stochastic RSI and Nasdaq

12/11/00 02:49:58 PM
by Dennis D. Peterson

If you combined the best features of RSI and stochastics into a single indicator, how well would it perform as a simple trading system?

Security:   $compq
Position:   N/A

Stochastics measures the position of the current closing price within a range of recent prices. RSI, on the other hand, measures how many days prices have been up versus how many days prices have been down for a recent period. StochRSI measures RSI with respect to a recent range of RSI values.

The formula for the stochastic of RSI for a given period is

stochRSI = (RSI- lowest RSI )/(highest RSI-lowest RSI),

and in Metastock this formula is

periods:=Input("RSI periods",1,100,14);
stochrsi:=(RSI(periods)-LLV(RSI(periods),periods))/(HHV(RSI(periods),periods)-LLV(RSI(periods),periods));
stochrsi

Like stochastic, stochRSI will range between zero and one. Since you are calculating where RSI fits in a range of recent values of RSI, stochRSI is going to be more responsive than RSI alone.


StochRSI is intended to show overbought and oversold levels, as well as the trend in RSI. I experimented with different period values and found that in a volatile market, short periods frequently cause stochRSI to be zero or one, making its use as a trend indicator difficult. On the other side of the coin I could see that it might function better as an overbought/oversold indicator with less dependence on period value. If it is reliable as an overbought/oversold indicator, you should be able to trade with stochRSI.

I decided to create a simple trading system for the Nasdaq using stochRSI. I would enter long if stochRSI was above an optimized value and exit the long position if stochRSI was below an optimized value. I also decided to let the system optimize on the number of periods. For the last five years of Nasdaq price history, optimization resulted in a period of 24 days, to enter long when stochRSI was greater than 0.3, and to exit long when stochRSI was below 0.3. When I optimized over the last 6 months of the Nasdaq, one of the differences was that optimization chose a period of 21 days and an entry threshold of 0.8.This means that you need to chart stochRSI to see where overbought and oversold thresholds are occurring.


Figure 1: Nasdaq Composite (top chart), Investment History(middle chart), and Stochastic RSI (lower chart).
Graphic provided by: MetaStock.
Graphic provided by: Data vendor: eSignal<.
 
When you look at the investment history (Figure 1:middle chart), the horizontal lines show where stochRSI was out of the market for a long position. Therefore, the right hand end of a straight line is when a long position was entered and the left hand end when the long position was closed. What's interesting is that stochRSI is out of the market during significant downturns, which is what you want when holding long positions. Unfortunately, during the most recent downturn this wasn't the case. This means you need to adjust thresholds if you get on automatic pilot with a trading system. Otherwise this is a valid indicator and, like other Chande and Kroll indicators, is very responsive.


Dennis D. Peterson

Market index trading on a daily basis.

Title: Staff Writer
Company: Technical Analysis, Inc.
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Seattle, WA 98116-4499
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E-mail address: dpeterson@traders.com

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