In a previous piece, https://www.plindia.com/blog/stochastic-oscillators-defined/, we had talked about how the Stochastic Oscillator can be a simple to understand yet powerful tool to pick stocks – just like its other cousin Williams % R. One often uses this indicator with something like RSI to gauge momentum and can give powerful insights into emerging trends
What if, therefore, there was a tool that captured it all in one single indicator!
Introducing Stoch RSI!
The Stochastic RSI indicator, developed by Tushard Chande and Stanley Kroll, is an oscillator that uses RSI values, instead of price values, as inputs in the Stochastic formula. The indicator measures where the RSI’s current value is relative to its high/low range for the specified period – thus becoming an indicator of indicators!
Like RSI, StochRSI cycles between overbought levels above 80 and oversold levels below 20. The StochRSI reaches these levels much more frequently than RSI, resulting in an oscillator that offers more trading opportunities. StochRSI moves within the range of 0 to 100. Unlike RSI, StochRSI frequently reaches the extreme 0 and 100 levels.
Calculation
StochRSI = [(Current RSI – Lowest Low RSI Value in n periods) / (Highest High RSI Value in n periods – Lowest Low RSI Value in n periods)] x 100
Why Create Another Version of the Stochastic Indicator?
The basic issue that Stochastic RSI handles is that the RSI can be oversold/overbought for extended periods of time without reaching the extreme levels – In order to address this , Chande and Kroll designed the Stochastics RSI to increase sensitivity to the RSI and generate more overbought and oversold signals.
How this indicator works
Chande and Kroll suggest setting Overbought/Oversold signals at 80/20 for Stochastic RSI rather than the 70/30 normally used for RSI.
- Go long when Stochastic RSI falls below the Oversold level then recovers above it;
- Go short when Stochastic RSI rises above the Oversold level then crosses below it;
That is, A buy signal would be generated when StochRSI advances from oversold (below 20) to above 20. Conversely, a sell signal would be generated when StochRSI declines from overbought (above 80) to below 80.
Of course, one should use a longer term trend filter to ensure that you only take trades in the direction of the trend. Exit on the opposite signal rather than reversing direction.
Note: As with many oscillators, StochRSI can become overbought (or oversold) and remain overbought (or oversold) for an extended period.Overbought doesn’t necessarily mean the price will reverse lower, just like oversold doesn’t mean the price will reverse higher. Rather the overbought and oversold conditions simply alert traders that the RSI is near the extremes of its recent readings.
- Crosses of the 50 level can be used as a buying or selling signal. When StochRSI crosses above 50 then buy, when StochRSI crosses below 50 then sell.
- If underlying prices make a new high or low that isn’t confirmed by the StochRSI, this divergence can signal a price reversal.
Remember, 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. Using trend lines or basic chart pattern analysis can help to identify major underlying trends and increase the Stoch RSI’s accuracy.
STOCHRSI vs RSI – which one is better?
It’s hard to say which is better because these indicators give you different data. You could say that the STOCH RSI is a measure of the strength of the normal RSI. However, since the first is actually an indicator of the latter, the normal RSI method is actually closer to the real price of the underlying.
Therefore, you might actually want to try using both and comparing them to draw your conclusion.
Predict The Nifty !
We have attached the current position of the Nifty Weekly charts below – and the indicator stack below it. You might want to see how you can play out the market for the next few weeks by thinking through what it means!
If you are interested in learning more about technical analysis, contact us at www.plindia.com/placademy or alternatively , if you wish to get in touch with us to open an account or be assisted in stock picking , email us at info@plindia.com
And yes, do come back to this piece after a while to see if the Stoch RSI prediction played out as you thought it would!