In 1994, Tushar S. Chande and Stanley Krolla published a book called “The New Technical Trader” — which explains a derivative of the Relative Strength Index or RSI called the Stochastic RSI. The two developed this indicator in order to increase sensitivity and to generate more signals than any traditional indicators could.
In order to fully enhance its effectiveness, the Stoch RSI should be used to complement other technical indicators.
Rather than processing standard price data, the Stochastic oscillator formula is applied to a set of RSI values instead — ranging between zero and one (or zero and 100 in some cases). By looking at the RSI values through the Stochastic formula, traders are able to figure out if the current RSI value is overvalued or undervalued.
Value dropping below 0.2 means the asset is likely to be oversold, whereas a value of 0.8 or above indicates that the asset could be overbought. The readings close to the centreline at 0.5 also provide some useful clues about the market trends.
When the reading goes above 0.5 at a steady pace and especially towards 0.8, it hints at the continuation of a bullish trend. Similarly, if it moves steadily below 0.5 and towards 0.2, it suggests a possible downward price movement.
Both Stoch RSI and RSI are banded oscillator indicators that help traders spot possible overvalued and undervalued conditions, in addition to potential trend reversals.
What sets the Stoch RSI apart from the standard RSI is that the latter produces less trading signals. What the Stoch RSI does is increase sensitivity, which produces significantly more signals. Thus, it provides traders more opportunities to anticipate for possible market trends and buying or selling points.
However, the fact that Stoch RSI is more volatile is also the reason why it is riskier due to some occasional false signals. It helps to apply Simple Moving Averages (SMA) so that the risks caused by false signals would be reduced. As such, it is common for a 3-day SMA to be included as a default setting for the Stoch RSI.
Some traders also pair Stochastic RSI with its cousin the standard RSI. A trader can deploy an easy to use crypto trading bot to execute a strategy based on Stochastic RSI.
