Technical Analysis, Studies, Indicators:
The Stochastic RSI indicator was developed by Tushard Chande and Stanley Kroll. It applies the Relative Strength Index (RSI) to the Stochastics formula, thus generating an oscillator that fluctuates between 0 and 1.
The RSI compares the magnitude of recent gains to the magnitude of recent declines; the results are presented within a range of 0 and 100. The RSI is calculated by means of the following formula:
RSI = 100 - 100/(1 + RS)
Stochastics is a momentum indicator that tracks an equities current close relative to its high / low range over a given number of periods. Stochastics is calculated using the following formula:
Stochastics = 100 * (Recent Close - Low(n)) / (High(n) - Low(n))
By inserting RSI in the Stochastics formula, the Stochastics RSI formula becomes:
Stochastics = (RSI(n) - Lowest RSI(n)) / (Highest RSI(n) - Lowest RSI(n))
- n is a number of periods used in the calculations;
- RSI(n) is the Relative Strength Index for n periods;
- Lowest RSI(n) is the lowest RSI(n) within the n periods;
- Highest RSI(n) is the highest RSI(n) within the n periods.
Stochastic RSI measures the value of RSI relative to its high / low range over a set number of periods.
- When the RSI records a new low for a given period, Stochastic RSI will be at 0. Moves to 0 are considered very weak.
- When the RSI records a new high for a given period, Stochastic RSI will be at 1. Moves to 1 are considered very strong.
A Stochastic RSI reading of 0.2 indicates that the current RSI is 20% above the lowest level noted in the analyzed period, or 80% below the highest level. Such a reading might be considered to indicate an oversold market; the reading could thus be interpreted as a buy signal. On the other hand, a Stochastic RSI reading of 0.8 shows that the current RSI is 80% above the lowest level of the period, or 20% below its highest level. Such a reading could be interpreted as indicating an overbought market and could be used as a buy sell signal.
As with many price oscillators, Stochastic RSI can become overbought (or oversold) and remain that way for a prolonged time. If the indicator stays above 0.80 for an extended period of time, it could indicate a strong uptrend. Conversely, a quick move below 0.20 could then indicate the beginning of a strong downtrend. Furthermore, we recommended that you use other technical indicators to confirm the overbought/oversold levels indicated by the Stochastic RSI.
Many traders complement their volume indicators with price indicators. These help to confirm situations where for instance the Stochastic RSI indicates overbought/oversold levels, or where it indicates a strong uptrend / strong downtrend:
- When Stochastic RSI readings above 0.8 are accompanied by volume surges, the indicator readings could be used as a sell signal; however, if the readings are not accompanied by volume surges, they could simply be ignored;
- When Stochastic RSI readings below 0.2 are accompanied by volume surges, the indicator readings could be used as a buy signal; however, if the readings are not supported by volume surges, they could simply be ignored.
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