What Is the Stochastic RSI?
The Stochastic RSI (StochRSI) is a potent technical analysis tool that spans a range typically between 0 and 1, or on some charting platforms, 0 to 100. This advanced indicator derives its values by applying the Stochastic Oscillator formula to a series of Relative Strength Index (RSI) values, instead of standard price data. By utilizing RSI values within the Stochastic formula, traders can better assess whether the current RSI reading is indicating an overbought or oversold condition.
The StochRSI was designed to make use of both momentum indicators, thereby creating an exceptionally sensitive gauge that reflects a specific security’s historical performance rather than merely a generalized overview of price changes.
Key Takeaways
- A StochRSI reading above 0.8 indicates an overbought condition; reading below 0.2 reflects oversold status. On the 0 to 100 scale, above 80 is overbought, and below 20 is oversold.
- Overbought status doesn’t necessarily forecast a price decline, and oversold doesn’t guarantee a rise. These conditions serve primarily as alerts that the RSI is nearing extreme levels.
- A zero reading signifies the lowest RSI value observed in the past 14 periods (or another predefined lookback span), while a one (or 100) marks the highest RSI level.
- Intermediate StochRSI values represent where the RSI stands relative to recent high or low points.
Formulas For Stochastic RSI (StochRSI)
Where:
- RSI = Current RSI reading
- min(RSI) = Lowest RSI level within the last 14 periods (or chosen interval)
- max(RSI) = Highest RSI level within the last 14 periods (or chosen interval)
How to Calculate the Stochastic RSI
The StochRSI’s foundation is anchored in RSI metrics, which typically cover 14 periods. These recorded RSI levels feed into the StochRSI formula as follows:
- Log RSI readings over 14 periods.
- Upon reaching the 14th period, note the concurrent RSI, as well as the highest and lowest RSI readings. Add these into the StochRSI formula.
- For the 15th period and onward, use the latest RSI value and adjust the previous 14-period RSI readings (omitting the 15th).
- Continuously recalculate the StochRSI using the freshest 14-period RSI data as each new interval concludes.
What Does the Stochastic RSI Tell You?
In their 1994 book The New Technical Trader, Tushar S. Chande and Stanley Kroll detailed how they developed the StochRSI to refine sensitivity and amplify signal generation compared to traditional indicators.
An asset is termed as ‘oversold’ when the StochRSI nears 0.20, hinting that the RSI is brushing the lower limits of its range, predicting a potential upward movement. Conversely, values above 0.80 may signal that the asset is reaching extreme highs and hint at an upcoming downward correction.
The oscillator’s design also aids short-term trend identification, particularly throughout the 0.50 to 0.50 centerline spectrum, flagging potential directional tendencies of the underlying asset.
For accuracy, the StochRSI should be complemented by other technical indicators or chart patterns to optimize utility and validate signals.
Pairing non-momentum oscillators like the accumulation/distribution line can provide unique perspectives devoid of any overlap in analytical functionality.
Difference Between the Stochastic RSI and RSI
Though resembling each other, StochRSI differs from RSI through its unique formula. While RSI is directly linked to price changes, StochRSI operates as a secondary derivative of RSI, therefore introducing a different sensitivity dynamic. Notably, StochRSI tends to swing rapidly between states compared to the more measured and slower trajectory of RSI.
Limitations of Using the Stochastic RSI
Despite its acute sensitivity, StochRSI is also markedly volatile, often oscillating rapidly from high to low values. One way to mitigate this is smoothing StochRSI with a moving average, thereby reducing volatility. Taking a 10-day simple moving average of the StochRSI, for instance, can produce a more consistent and reliable indicator. Many charting methods facilitate integrating such indicators without necessitating manual computations.
Keep in mind, as a second derivative of price, StochRSI is distantly linked from an asset’s actual market valuation, which might result in occasional desynchronization with real-time market behaviors.
Related Terms: RSI, Stochastic Oscillator, Moving Average, Overbought, Oversold
