- Stochastic RSI is a technical indicator used by traders to analyse the stock market.
- This indicator applies the Stochastic oscillator formula to the relative strength index (RSI) to find out the points where the stock is overbought or oversold.
Formula used to calculate the StochRSI:
- RSI = Current RSI value;
- min[RSI] = least value of RSI over the last n periods; (generally 14 periods)
- max[RSI] = highest value of RSI over the last n periods;
Formula used to calculate the RSI:
This is the 1 day chart of United Breweries Ltd (BSE) around Nov, 2019 to Aug, 2020
- The StochRSI ranges between 0 and 100. In some websites, the range used is 0 to 1, which is obtained by dividing the value by 100.
- If the value lies between 0 and 20, it indicates that the stock is oversold and if the value lies between 80 and 100, it indicates that the stock is overbought.
- If the indicator value is below 20, it indicates that the stock is trading at the lower end of the range and there is a chance of trend reversal. At that point, traders can enter the trade and initiate their long positions.
- Similarly, if the indicator value is above 80, it indicates that the stock is trading at the higher end of the range and there is a chance of trend reversal. At that point, traders can enter the trade and initiate their short positions.
- Traders can also mark a centre line at 50. If the value crosses above the line, it indicates that the stock is trading higher and if the value crosses below the centre line, it indicates that the stock is trading lower.
- The main disadvantage of the StochRSI indicator is that it involves complex calculations. Moreover, overbought and oversold signals do not always indicate a trend reversal.
- Inexperienced traders may use the false results and fall into losses. Hence, StochRSI indicator should be used along with other indicators to minimise the risk and avoid losses.