Stanley Kroll and Tushar Chande together described a momentum oscillator, Stochastic RSI, in the ‘The New Technical Trader.’ This book talks about how every tick affects the market. You can use it to check if your chosen technical indicators are well-suited for your trading strategy. Stochastic RSI is a momentum oscillator, meaning it measures the change in the price of a security over a period of time. Stochastic RSI also generates overbought and oversold market signals, but it does it more efficiently than its contemporary, Relative Strength Index.
How does Stochastic RSI work?
Stochastic RSI represents the oscillator indicator that uses the Stochastic formula to a set of Relative strength index (RSI) values instead of standard close price data. The stochastic indicator works as an oscillator that increases the regular RSI indicator’s sensitivity and reliability when trading off overbought and oversold RSI price levels.
When we look chart, we can ask this question:
What are the two lines in stochastic RSI?
Two lines in stochastic RSI are the fast line called “%K.” and the slower line, called “%D,” representing a moving average of %K. Both lines are calculated using the stochastic formula applied to the closing price of RSI.
Stochastic RSI MT4 Download
Stochastic RSI vs. RSI
Difference between Stochastic RSI and RSI
The difference between stochastic RSI and RSI is that the RSI oscillator measures the speed and change of price movements using the closing price of a security to a range of its prices over a certain period of time. On another side, the stochastic RSI measures the RSI momentum and is based on RSI’s closing price.
Difference between Stochastic and Stochastic RSI
The difference between stochastic and stochastic RSI is that the stochastic oscillator measures momentum using the closing price of a security to a range of its prices over a certain period of time, and on another side, the stochastic RSI measures the momentum of the RSI and is based on the closing price of RSI.
Trading with RSI and stochastic indicators
According to Kroll and Chande, the ideal setting for overbought/oversold signals is at 80/20. This is different than the usual 70/30 setting of a normal RSI.
Understanding trading signals:
- As the Stochastic RSI falls and comes down below the oversold level before recovering, it’s time to go long.
- As the Stochastic RSI rises and crosses over the oversold level before falling, it’s time to go short.
It is better to use this momentum oscillator with a trend filter to confirm the trend’s direction. You can follow it and plan your exit when the signal is opposite rather than in reverse.
Following the Trend using Stochastic RSI
This momentum oscillator still has the same problem as its counterparts; it can push the traders out of the trade too early, especially when the trend is week. Therefore this oscillator should not be used alone. You must use it with trend filters to ensure that the signal’s strength doesn’t push you out prematurely. You can use Stochastic RSI in conjunction with the Moving Averages or other non-momentum oscillators like the accumulation distribution line.
Setting Up Stochastic RSI
Like most of the technical indicators, this oscillator also comes with a default setting of 14 days. The overbought/oversold levels are set at 80/20. If you wish to change the settings, you need to adjust the indicator panel settings.
- Go to Indicators and select Stochastic RSI. You will find it in the panel’s left column.
- You will come across ‘Edit Indicator Settings.’ Click on it, and you will get the option of changing the default settings.
- You can even change the indicator colors. You will see an ‘L’ on the toolbar. If you can’t spot it, type ‘L’ on your keyboard. You can adjust individual colors by using the color patches.
Stochastic RSI Calculation – stochastic RSI formula
Stochastic RSI formula is:
X is a period usually 14
RSI = Current RSI reading;
Lowest RSI = Lowest RSI in last X periods
Highest RSI = Highest RSI reading in the last X period
This is how you can the Stochastic RSI value:
- First, you need to calculate the RSI or the Relative Strength Index for a chosen period of time of a data series.
- Once you have your RSI value, subtract the minimum value for the chosen period from the latest RSI value.
- Again, subtract the minimum value for the chosen period but from the highest RSI value. Keep in mind that the time period should be the same.
- No divide the result you got from point number 2 by the result you got from point number 3. This will give you the Stochastic RSI value.
Stochastic RSI trading strategy
Usually, the stochastic RSI indicator strategy is based on the idea to BUY when the main trend is in bullish and stochastic lines cross in the oversold area and to SELL when the main trend is bearish and stochastic lines cross in the overbought area.
This indicator can be used to buy or sell a security when it is in pullback mode, after correction.
Stochastic RSI trading strategy example:
BUY if the price is above SMA 100 on the H1 chart AND stochastic RSI lines K and D are just crossed in the oversold area.
Sell if the price is below SMA 100 on the H1 chart, AND stochastic RSI lines K and D are just crossed in the overbought area.