How to use Stochastic RSI

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The Stochastic Oscillator is a popular trading indicator that follows the speed of price action momentum.

The Stochastic RSI, or Stoch RSI, is an indicator that applies the same oscillator principle to data derived from an asset’s RSI (relative strength index) instead of price action.

Stoch RSI is an indicator of an indicator that uses data from the popular RSI indicator. It can help you identify when a market is overbought or oversold. 

Here’s the formula used for calculating Stoch RSI:

Stoch RSI = (RSI - Lowest Low RSI)/(Highest High RSI - Lowest Low RSI)

Like the traditional Stochastic Oscillator, Stoch RSI can be configured to use data from different trading periods.

With a period setting of 14, the RSI values for “Lowest Low RSI” and “Highest High RSI” will be extracted from the past 14 trading periods (14 days on a daily chart, 14 hours on an hourly chart and so on).

So, how can we interpret data from the Stoch RSI?

With a period setting of 14:

  • A Stoch RSI reading of 100 indicates the asset’s RSI level is at its highest level in the past 14 periods.
  • A Stoch RSI reading of 80 indicates the asset’s RSI is near its high from the past 14 periods.
  • A Stoch RSI reading of 50 indicates the asset’s RSI is in a neutral position.
  • A Stoch RSI reading of 20 indicates the asset’s RSI is near its low from the past 14 periods.
  • A Stoch RSI reading of 0 indicates the asset’s RSI level is at its lowest level in the past 14 periods.

When an asset’s Stoch RSI reading drops below 20, it is considered oversold

A level greater than 80 indicates overbought.

Like the Stochastic Oscillator, Stoch RSI is also commonly accompanied by a 3-day moving average.

Stochastic RSI trading strategies

Divergence Between Stoch RSI and Price

We know that “divergence between price and an oscillator or other market indicator can often signal an imminent trend reversal in the near future.”

This principle applies to divergence between price action and Stoch RSi as well.

In the 1-hour BTC/USD chart below, the price of BTC makes a higher high while the Stoch RSI indicator prints a lower high.

Following the divergence, BTC retraces 7% to the downside to seek equilibrium.

In the 4-hour chart XRP/USD chart below, a bullish divergence between price action and Stoch RSI can be observed.

Notice how price makes a lower low, while Stock RSI makes a higher low.

What follows is an explosive 40% move to the upside for XRP.

Stoch RSI can be a useful tool when used in conjunction with trendlines, candlestick patterns and other trading indicators.

Using Stoch RSI by itself is not recommended because it’s a second-order indicator that is two steps away from real-time market price action.

On this ETH/USD 1D chart, a huge bullish divergence can be observed.

Remember, RSI, and thus the Stoch RSI, can show oversold or overbought readings for an extended period of time.

Don’t blindly enter trades on the first or even second sign of divergence. It’s almost always better to wait for a cross back up or down to normal RSI ranges and confluence from other trading indicators like MACD, OBV, candlestick patterns, and more.

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