Stochastic RSI basics
Stochastic RSI was developed to increase sensitivity and reliability of the regular RSI indicator when it comes to trading off overbought/oversold RSI levels.
The authors of the Stochastic RSI indicator - Tushard Chande and Stanley Kroll - explain that often regular RSI indicator would trade in between 20 and 80 levels for extended periods of times without ever reaching an oversold/overbought areas where many traders seek trading opportunities.
When combining RSI with Stochastic, a new indicator - Stochastic RSI - provides better and more distinctive signals to trade upon.
Let's compare regular RSI and Stochastic with their new improved version - Stochastic RSI:
As we can see, unlike other indicators Stochastic RSI was able to reach overbought/oversold levels all the time and even remain there longer before moving in the opposite direction.
Let's now take a closer look at the overbought/oversold levels created by Stochastic RSI:
How to trade with Stochastic RSI
When trading with Stochastic RSI traders look for the following signals:
1. Trading with Stochastic RSI oversold/overbought levels:
When StochRSI exits from oversold (below 20) level up - Buy.
Notice, that unlike with RSI, where we used 30 and 70 levels as oversold/overbought, here we use 20 and 80, same as for Stochastic indicator.
Another point to notice is that we react to indicator signals only after d% line (the thin brown line on the screen shot) has reached overbought/oversold levels as well. If, this line has never entered the overbought/oversold area, any signals to Buy/Sell as StochRSI exits 20 or 80 should be temporarily ignored.
2. Crossover of the center line of StochRSI suggest a current trend.
Stochastic RSI formula
Stochastic RSI = ((Today's RSI - Lowest RSI Low in %K Periods) / (Highest RSI High in %K Periods - Lowest RSI Low in %K Periods)) * 100
Stochastic RSI measures the value of RSI in relation to its High and Low range over the required period: