Both the relative strength index (RSI) and stochastic oscillator are price momentum oscillators that are used to forecast market trends. Despite their similar objectives, they have very different underlying theories and methods. The stochastic oscillator is predicated on the assumption that closing prices should close near the same direction as the current trend. The RSI tracks overbought and oversold levels by measuring the velocity of price movements. More analysts use the RSI over the stochastic oscillator, but both are well-known and reputable technical indicators.
J. Welles Wilder Jr. developed the RSI by comparing recent gains in a market to recent losses. RSI values range from 0 to 100 and are plotted on a line underneath the price chart. The midpoint for the line is 50. When the RSI value trends above 70, the underlying asset is considered to be overbought. Conversely, the asset is considered oversold when the RSI reads below 30. Traders also use the RSI to identify areas of support and resistance, spot divergences for possible reversals and confirm the signals from other indicators.
Stochastic oscillators were created by George Lane. Lane believed that prices tend to close near their highs in uptrending markets and near their lows in downtrending ones. Like the RSI, stochastic values are plotted in a range bound between 0 and 100. Overbought conditions exist when the oscillator is above 80, and the asset is considered oversold when values are below 20. Stochastics actually uses two lines (known as K and D lines) and a crossover analysis can be performed based on the relationship between each of them.
Generally speaking, the RSI is more useful in trending markets, and stochastics are more useful in sideways or choppy markets. The RSI was designed to measure the speed of price movements, while the stochastic oscillator formula works best in consistent trading ranges.