Stochastic RSI (StochRSI) Definition, Examples, and Real-World Uses (2024)

The stochastic relative strength index (stochRSI) is a technical indicator that greatly influences how technically-minded investors read market momentum. While it may sound like arcane financial jargon, this powerful tool has been credited with predicting major market moves, sometimes days before they occur.

StochRSI is a sophisticated step up from the widely-used relative strength index (RSI). By applying a stochastic oscillator formula to RSI values, the stochRSI aims to provide a more nuanced view of overbought and oversold conditions (that is, when prices are too high or too low) for financial assets. In an era where algorithmic trading dominates and market volatility can spike instantly, tools like the stochRSI are part of a vast arsenal institutional and retail investors use to navigate turbulent market waters. Today, these instruments make doing so more like having advanced GPS over the star charts of earlier centuries' navigation.

Below, we examine how traders use this indicator to inform their strategies, its potential advantages over traditional RSI, and the pitfalls to watch out for when relying on this or any single technical indicator.

The Formulas For the Stochastic RSI (StochRSI)

$\begin{aligned} &\text{StochRSI}=\frac{RSI-\min\left[{RSI} \right ]}{\max\left[{RSI} \right ] - \min\left[{RSI} \right ]}\\ &\textbf{where:}\\ &RSI = \text{Current RSI reading}\\ &\min\left[{RSI} \right ] = \text{Lowest RSI reading over the last 14 periods}\\ &\;\text{(or your chosen lookback interval)}\\ &\max\left[{RSI} \right ] = \text{Highest RSI reading over the last 14 periods}\\ &\;\text{(or your chosen lookback interval)} \end{aligned}$​StochRSI=max[RSI]−min[RSI]RSI−min[RSI]​where:RSI=CurrentRSIreadingmin[RSI]=LowestRSIreadingoverthelast14periods(oryourchosenlookbackinterval)max[RSI]=HighestRSIreadingoverthelast14periods(oryourchosenlookbackinterval)​

How To Calculate Stochastic RSI

The stochRSI is basedon RSI readings. The RSI has an input value, typically 14, which tells the indicator how many periods of data it is using in its calculation. These RSI levels are then used in the stochRSI formula.

1. Record RSI levels for 14 periods.
2. During the 14th period, note the present, highest, and lowest RSI reading. It's now possible to fill in all the formula variables for stochRSI.
3. In the 15th period, note the present, highest, and lowest RSI reading, but only for the last 14 periods (not the last 15). Compute the new stochRSI.
4. As each period ends, compute the new stochRSI value, using only the last 14 RSI values.

What Does the Stochastic RSI Tell You?

The stoch RSI was developed by Tushar S. Chande and Stanley Kroll and detailed in their book "The New Technical Trader," first published in 1994. While technical indicators already existed to show overbought and other conditions when prices were poised to rise or fall levels, the two developed stochRSI to improve sensitivity and generate a greater number of signals than traditional indicators could do.

StochRSI deems something to be oversold when the value drops below 0.30, meaning the RSI value is trading at the lower end of its predefined range, and that the short-term direction of the underlying security may be nearing a low a possible move higher. Conversely, a reading above 0.70 suggests the RSI may be reaching extreme highs and could be used to signal a pullback in the underlying security.

Along with identifying overbought or oversold conditions, stochRSI can be used to identify short-term trends by looking at it in the context of an oscillator with a centerline at 0.50. When the stochRSI is above 0.50, the security may be seen as trending higher, and vice versa when it's below 0.50.

StochRSI should also be used with other technical indicators or chart patterns to improve its effectiveness, which is especially important given the high number of signals that it generates.

In addition, non-momentum oscillators like the accumulation distribution line may be particularly helpful because they don't overlap in functionality and provide insights from a different perspective.

Stochastic RSI vs. the Relative Strength Index (RSI)

Though similar, stochRSI relies on a different formula than RSI. RSI is a derivative of price, while stochRSI is derived from RSI itself. One key difference is how quickly the indicators move. StochRSI moves very quickly from overbought to oversold or vice versa, while RSI is a much slower-moving indicator. One isn't better than the other: stochRSI just moves more (and more quickly) than the RSI.

Limits of Using Stochastic RSI

One downside to using the stochRSI is that it tends to be quite volatile, rapidly moving from high to low. Smoothing the stochRSI may help in this regard. Some traders will take a moving average of the stochRSI to reduce the volatility and potentially make the indicator more useful. For example, a 10-day simple moving average of the stochRSI can produce an indicator that's much smoother and more stable. Most charting platforms allow for applying one type of indicator to another without any personal calculations required.

Also, the stochRSI is the secondderivative of price. In other words, its output is two steps away from the actual price of the asset being analyzed, which means it could be out of sync with an asset's market price in real time.

Now that we better understand the differences between this and other indicators, as well as potential drawbacks, let's look at the differences in calculating stochRSI vs. RSI vs. the stochastic oscillator:

The Bottom Line

StochRSI is a transformed version of the traditional RSI that enhances sensitivity and provides more frequent trading signals. By applying the stochastic oscillator formula to the values derived from the RSI, stochRSI offers a good tool for identifying overbought and oversold conditions in the market.

Its utility in various trading strategies, particularly when combined with other technical indicators, makes it a valuable asset for traders and investors looking to refine their security and market analysis.