What is a stochastic RSI and how does it work?
Stochastic, or simply StochRSI, is a technical analysis indicator that can be used to determine the overbought and oversold nature of assets as well as current market trends. StochRSI, which is derived form the standard relative strength indicator (RSI), is an indicator of that indicator. This oscillator is one of a kind. It oscillates above or below the center line.
Stanley Kroll and Tushar Chaud first described StochRSI in 1994’s The New Tech Trader. It is most commonly used by stock traders but it can also be used in other trading contexts, such as Forex or cryptocurrency markets.
What is the working principle of StochRSI?
StochRSI is a metric that is created from a regular RSI using the Stochastic Oscillator method. This results in a single numerical rating, which hovers around the middleline (0.5) within the range of 0-1. There are also modified versions of StochRSI indicators that multiply the results 100 times, so the values can range from 0 and 1 instead of 0 or 1. A 3-day simple moving average (SMA), along with the StochRSI Line is common. This is to help reduce trading on false signals.
The standard stochastic oscillator formula takes into account the asset’s closing price and its maximum and minumum points over a period. A formula can be used to calculate StochRSI. However, prices are not included in the calculation.
Stoch RSI = (Tekushchii RSI - Samyi nizkii RSI) / (Samyi vysokii RSI - Samyi nizkii RSI)
The most common time setting for StochRSI is the same as standard RSI. It uses 14 periods. Based on the time interval in the chart, the 14 periods used for StochRSI calculations are determined. The daily chart will consider the last 14 days (candlesticks), but the hourly chart will calculate StochRSI using the last 14 hours.
You can set periods in days, hours or minutes. Their usage will vary from trader-to-trader depending on their strategy and profile. You can adjust the number of periods to find long-term and short-term trends. Another popular version of the StochRSI indicator is the 20-period setup.
Some StochRSI graphic templates assign values between 0 and 100, instead of 0 or 1. These charts have a center line at 50, instead of 0.5. The overbought signal (which is usually at the level 0.8) will be indicated at 80 and the oversold signal at 20. Although charts with a setting of 0 to 100 may look different, the practical interpretation is the same.
How do I use StochRSI?
The StochRSI indicator has the highest value at the lower and upper limits of its range. The main purpose of the indicator is to identify entry and exit points as well as price reversals. A value of 0.2 or less indicates that the asset may be oversold. A value of 0.8 and higher suggests that it might be overbought.
Market trends can also be derived from readings that are closer to the centerline. If the StochRSI lines are moving above the 0.5 mark as a support, it could indicate that there is a bullish or upward trend, particularly if they move towards 0.8. Values below 0.5 are more common than 0.2 and indicate a bearish or downtrend.
StochRSI vs RSI
StochRSI as well as RSI both are band oscillator indicators which make it easier to spot overbought or oversold conditions and possible pivot points. A standard RSI, in short, is a metric that tracks how rapidly and to what extent asset prices change relative to a time period (period).
The standard RSI is a slower-moving indicator and produces fewer trading signals than the stochastic RSI. StochRSI was created by applying the stochastic oscillator algorithm to a traditional RSI. This allows for an indicator with greater sensitivity. It produces more signals, which allows traders to spot market trends and potential sell or buy points.
StochRSI, which is a volatile indicator, can provide traders with more trading signals. However, it is also more risky as it generates a lot of noise (false signal). The common method of reducing false signals is to use simple moving averages (SMAs). In many cases, the three-day SMA setting is the default setting for StochRSI.
The stochastic RSI is a useful indicator for traders, analysts, and investors. It can also be used for short-term and long term analysis. StochRSI can generate more signals, but that also means more risk. This is why it should be used in conjunction with other technical analysis tools to confirm its signals. Remember that cryptocurrency markets can be more volatile than traditional ones, and therefore, may generate more false signals.