Stochastic RSI, or simply StochRSI, is a technical analysis indicator used to determine whether an asset is overbought or oversold, as well as to determine current market trends. As the name suggests, StochRSI is a derivative of the standard Relative Strength Index (RSI) and as such, is considered an indicator indicator. It is a type of oscillator, meaning it fluctuates above and below a center line.

StochRSI was first described in 1994, in the book The New Technical Trader by Stanley Kroll and Tushar Chande. It is often used by stock traders, but can also be used in other trading aspects, such as Forex or cryptocurrency trading.


How does StochRSI work?

The StochRSI indicator is generated from the regular RSI by applying the Stochastic Oscillator formula. The result is a single numerical rating that fluctuates around a center line (0.5) ranging from 0 to 1. However, there are modified versions of StochRSI that multiply the results by 100, so the value ranges from 0 to 100 instead of 0 and 1. Also A 3-day simple moving average (SMA) is often seen along with the StochRSI line, which acts as a signal and is intended to reduce trading risk.

The standard Stochastic Oscillator formula takes into account the closing price of an asset, as well as its highest and lowest points during a certain period. However, when the formula is used to calculate StochRSI, it is directly applied to data from RSI (prices are not taken into account).

Stoch RSI = (Current RSI - Lowest RSI)/(Highest RSI - Lowest RSI)

Like the standard RSI, the most commonly used setting for the StochRSI is 14 periods. The 14 periods involved in the StochRSI calculation are based on the chart time frame. So while the daily chart will take into account the last 14 days (candles), the hourly chart will generate StochRSI based on the last 14 hours.

Periods can be set in days, hours or even minutes, and their use varies greatly from trader to trader (depending on their strategy). The number of periods can also be adjusted up or down to determine long-term or short-term trends. The 20-period setting is another quite popular setting for StochRSI.

As mentioned, some StochRSI chart templates assign values ​​ranging from 0 to 100 instead of 0 to 1. On these charts, the center line is at 50 instead of 0.5. Therefore, an overbought signal, which usually occurs at the 0.8 level, will be indicated as 80, and an oversold signal, at the 20 level, rather than 0.2. Graphs adjusted from 0 to 100 may look slightly different, but the practical interpretation is essentially the same.


How to use StochRSI?

The StochRSI indicator acquires its greatest value near the upper and lower boundaries of its range. Therefore, the main use of the indicator is to identify potential entry and exit points, as well as price reversals. Thus, a value of 0.2 or below indicates that the asset is likely to be oversold, while a value of 0.8 or above suggests that it may be overbought.

Additionally, finding lines closer to the center can also provide useful information regarding market trends. For example, when the center line acts as support and the StochRSI lines move consistently above the 0.5 mark, this could indicate a continuation of a bullish or uptrend, especially if the lines begin to move in the direction of 0.8. Likewise, consecutive fluctuations below 0.5 and deviations towards 0.2 indicate a downward or bearish trend.


StochRSI vs. RSI

StochRSI and RSI are oscillator band indicators that allow traders to more easily identify potential overbought and oversold conditions, as well as possible reversal points. In short, standard RSI is a metric used to track how quickly and to what extent the price of an asset changes in relation to set time intervals (periods).

However, compared to the Stochastic RSI, the standard RSI is a relatively slow indicator that produces a small number of trading signals. Applying the Stochastic Oscillator formula to the regular RSI allowed us to create StochRSI as an indicator with increased sensitivity. Consequently, the number of signals it generates is much higher, giving traders more opportunities to identify market trends and potential buy or sell points.

In other words, StochRSI is a fairly volatile indicator, and while this makes it a more sensitive TA tool that can help traders with more trading signals, it is also riskier since it often generates a significant amount of noise (false signals). As mentioned, using simple moving averages (SMAs) is one common method of mitigating the risks associated with these false signals, and in many cases the three-day SMA is already included as a default setting for the StochRSI indicator.


Conclusion

Due to its greater speed and sensitivity to market movements, the Stochastic RSI can be a very useful indicator for analysts, traders and investors for both short- and long-term analysis. However, more signals also mean more risk, and for this reason StochRSI should be used in conjunction with other technical analysis tools that can help confirm the signals it creates. It is also important to remember that cryptocurrency markets are more volatile than traditional ones, and as such, may generate an increased number of false signals.