Stochastic RSI applies the Stochastic Oscillator to the Relative Strength Index (RSI) to measure changes in RSI. Stochastic RSI helps increase the sensitivity of standard RSI readings, which measures a security's average change in price over time, and is thought to better indicate when a security is overbought or oversold.
An oscillator, Stochastic RSI fluctuates between 0 and 1. When RSI experiences a record high, Stochastic RSI will be 1 and when RSI experiences a record low, Stochastic RSI will be 0. And, a reading of 0.40, for example, indicates that RSI is 40% higher than its lowest low and 60% lower than its highest high.
In general, any readings above 0.80 are thought to indicate a security is overbought and any readings below 0.20 are thought to signify a security is oversold. When Stochastic RSI crosses below 0.80 during an uptrend, it could mean the security's price might soon experience a reversal. And, if Stochastic RSI moves above 0.20 during a downtrend, prices may begin to rise.
However, it's always important to keep in mind that prices may remain at overbought and oversold periods for extended periods of time. It's not always the case that a security will experience a reversal as soon as either of these levels is reached. When the Stochastic RSI remains at these levels for an extended period of time, it's an indication of a strong uptrend when readings are above 0.80, or a strong downtrend when readings are below 0.20.
Positive and negative divergences can give additional clues about a security's price movement. A positive divergence followed by a move above 0.20 may be a signal of an approaching uptrend. And, a negative divergence followed by a move below 0.80 could be a signal of an impending downtrend.
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
The strategies described in this article are for information purposes only, and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.