The Stochastic RSI was developed to increase the sensitivity and reliability of the regular RSI indicator especially when the trader wants to trade  during periods when the RSI is in overbought/oversold condition.

The creators of this indicator -Tushard Chande and Stanley Kroll-explain that very often the RSI oscillator remains at the levels 20 and 80 for extended periods of time without even reaching the overbought and oversold areas where many traders look for opportunities to enter the market.

Therefore, when the RSI is combined with the stochastic oscillator, a new indicator, the Stochastic RSI, offers better and clearer signals for opening and closing positions.
Now let's compare the traditional RSI and stochastic oscillator with the Stochastic RSI on the same chart:

As we can see, unlike other indicators, the RSI Stochastic was able to reach the overbought/oversold levels on more occasions and even remained in these levels longer before moving in the opposite direction.

Now let's look more closely at the overbought and oversold created by the RSI Stochastic:

Rules to trade with the Stochastic RSI

When the Stochastic RSI is used to analyze the market the trader should look for the following signs:
  • Wait for the stochastic RSI reaches overbought and oversold levels:
    • When the RSI leaves the oversold zone (below 20), we can open a buy position.
    • When the RSI leaves the overbought zone (above 80), we can open a short position.
We note that unlike the RSI, where we use the levels 30 and 70 to indicate oversold/overbought conditions, in this indicator the levels used are 20 and 80, the same as in the case of stochastic oscillator.

Another point to consider is that the reaction to signals from the indicator should occur only after the d% line  (the thin yellow line) has also reached the overbought/oversold levels. If this line has not entered the overbought/oversold zone, any buy/sell signal from the Stochastic RSI  produced when it crosses the level 80 downwards or the level 20 upwards, should be ignored, at least temporarily.

Any cross of the centerline of the Stochastic RSI (level 50) suggests a trend.
  • Above 50, the trend is up.
  • Below 50, the trend is down.
These are the two most effective ways of trading with the Stochastic RSI. The rest, as the trading based on price-indicator divergences, are less effective in this indicator compared to the MACD and stochastic oscillator.

Stochastic RSI formula

-Stochastic RSI = (RSI – Lowest Low RSI) / (Highest High RSI – Lowest Low RSI)
The Stochastic RSI measures the value of RSI relative to its maximum and minimum value throughout the period of time required. When the regular RSI reaches a new low during the period, Stochastic RSI is 0. When the regular RSI reaches a new high during the period, the stochastic RSI is 100.

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