What is Stochastic RSI and How To Use It in Trading?

  • Home
  • What is Stochastic RSI and How To Use It in Trading?

What is Stochastic RSI and How To Use It in Trading?

What is Stochastic RSI and How Can You Use It in Trading?-BitDelta

Summary

  • Stochastic RSI (StochRSI) is created based on the Relative Strength Index (RSI) and the Stochastic oscillator to provide more trading signals than the original RSI indicator.

  • Stochastic RSI takes a value between 0 and 1 (or 0 and 100) which shows overbought and oversold market conditions.

  • StochRSI is normally calculated over 14 days. To have StochRSI, you need to first calculate the regular RSI in the selected period. You would also need the highest and lowest RSI during the period over which you calculated your RSI.

  • A reading of 0.2 or less would indicate that the market is experiencing an oversold situation. On the other hand, a reading of 0.8 or more would show an overbought condition.

  • Stochastic RSI works best when used with other indicators and it is not recommended to use it alone.

Table of Contents

What is Stochastic RSI?

Stochastic RSI (StochRSI) is created based on the Relative Strength Index (RSI) and the Stochastic oscillator to provide more trading signals than the original RSI indicator.Stochastic RSI observes the price movements and momentum and reacts to them more frequently than the regular RSI.

Stochastic RSI takes a value between 0 and 1 which shows overbought and oversold market conditions. Some charting tools may also show its value between 0 and 100 in the same way as the RSI indicator.

stochastic RSI Bitcoin

Stochastic RSI on a Bitcoin Chart on the BitDelta Spot Exchange

To understand Stochastic RSI better, you need to first learn how the RSI and stochastic oscillator work. Let’s have a quick overview of both indicators here as well.

Relative Strength Index, or RSI for short, measures the momentum of the price and translates it into a value between 0 and 100.

RSI is usually interpreted based on the 30 and 70 levels. If RSI is below 30, it’s likely that the market is going through an oversold condition.
On the other hand, a reading of 70 shows an overbought condition for the asset. In both cases, market members usually prepare themselves for a change in the market trend as the asset is either below or above its true value and may adjust soon.

The stochastic oscillator tries to measure the same; it observes the price movements to predict when a reversal may be imminent. The stochastic oscillator also moves between 0 and 100.

In general, a reading above 80 would indicate that the market is in overbought condition while a reading below 20 shows the asset is changing hands below its true value and is oversold. In both conditions, a trend reversal may happen soon to adjust the market price.

Now that we have a basic understanding of both RSI and the stochastic oscillator, let’s see how we can use both to calculate the stochastic RSI or StochRSI.

How is Stochastic RSI Calculated?

RSI is normally calculated over 14 periods (e.g. 14 days), however, you can choose your own setting that would suit your trading strategy the best.

Before getting into details, you should know that modern charting tools will calculate StochRSI automatically for you and will allow you to adjust the settings easily, however, it is always good to know the basics of the tools you use to trade.

To calculate StochRSI, you need to first calculate the regular RSI in the selected period. You would also need the highest and lowest RSI during the period over which you calculated your RSI.

Here’s the formula for calculating stochastic RSI:

What Does the Stochastic RSI Look Like on a Chart?

Now, let’s see what the actual stochastic RSI looks like on a chart. Here, we have a stochastic RSI with the regular settings on an Ethereum chart.

Stochastic RSI on an Ethereum Chart on the BitDelta Spot Exchange

The StochRSI is calculated over 14 days. The blue line is the actual StochRSI which is also known as the %K. We also have an orange line which is actually a 3-period moving average of the %K. This line is known as the %D.

As a moving average, the %D is slower than the %K and reacts slower to the price. You can see this on the chart as the orange line is always reacting to the price after the blue line.

You can simply change the settings of the StochRSI including the moving-average period to match your trading preferences.

How to Use Stochastic RSI in Trading?

Traders use stochastic RSI to gauge the market condition and see if they can find favorable buy or sell positions.

Overbought/Oversold Signals

As mentioned before, the value of StochRSI ranges between 0 and 1 (or 0 to 100). A reading of 0.2 or less would indicate that the market is experiencing an oversold situation. On the other hand, a reading of 0.8 or more would show an overbought condition.

These extreme market conditions are hinting that a trend reversal may be happening, however, nothing is guaranteed in financial markets. Based on this, traders try to sell their assets in an overbought condition while an oversold signal can present good entry positions.

Stochastic RSI works best when used with other indicators, and it is not recommended to use it alone.

Stochastic RSI along with other technical indicators

Stochastic RSI can create numerous signals which can be confusing for some traders. To increase the effectiveness of Stochastic RSI and filter out excessive signals, traders and investors try to use this indicator along with other technical indicators and chart patterns.

Share:
Most Popular
Stay In The Know
Our articles will find their way to your mail Box!
Social Media