Technically, Tushar Chande and Stanley Kroll created the indicator Stochastic Relative Strength Index (RSI). StochRSI is more commonly known by its abbreviation.
This well-known indicator comprises two components: the Stochastic Oscillator (SO) and the Relative Strength Index (RSI).
When developing a trading strategy, one of the most common ways to use the stochastic relative strength index (StochRSI) is to look for readings that fall between the overbought and oversold ranges.
Readings below 0.2 are considered oversold, whereas readings above 0.8 are considered overbought.
The StochRSI is measured on a scale from 0 to 1, with 0 representing the midpoint.
Overbought conditions during a larger downtrend are interpreted as bearish signals, while oversold conditions during a larger uptrend are interpreted as bullish signals.
However, extreme caution is required due to the extreme volatility of the stochastic relative strength index.
Following an overbought or oversold reading, trade entries should not be made until the subsequent price action confirms the move.
For example, readings indicating that an asset is overbought should not be interpreted as an entry signal, but rather as a caution regarding a potential move.
To demonstrate that the bearish trend is still in effect, the StochRSI indicator must move back below the 0.5 centerline.
Following oversold readings, the stochastic RSI cannot rise above 0.5 unless a larger bullish trend develops.
If the stochastic RSI remains in the oversold or overbought zones for an extended period of time, a trend change may be imminent.
Suppose a particular security has been moving sharply downward for a number of weeks, with RSI readings ranging from 18 to 60.
The RSI currently displays a reading of 56 for the current session. According to the StochRSI calculation, this RSI reading, which is typically not considered an actionable indicator, paints a different picture than the conventional interpretation.
This session's StochRSI value is (56 - 18) / (60 - 18), which is equal to 0.9. Due to the significant overbought signal that developed within the larger downward trend, the price is likely to continue falling after the bullish correction concludes.
Use market or limit orders, depending on your preference, to initiate a short position as soon as the StochRSI falls below 0.5.
Place a stop-loss order at the point where the bullish retrace made its highest high. Once before, the bulls attempted to move the price beyond this level, but they were unsuccessful.
If the price rises above this level, the bearish trend may come to an end.
The stochastic relative strength index (StochRSI) generates a large number of signals, both positive and negative; therefore, it is prudent to seek out additional indicators that support the continuation of a trend.
StochRSI signals are amplified when persistently high volume and candlestick patterns, such as the falling three methods, are present.
The Stochastic Oscillator and the Relative Strength Index are oscillator-related indicators. On a price chart, prices tend to follow a similar pattern in many instances.
So, is there any reason to utilize both simultaneously? The response is YES. But it must be done intelligently.
In addition to oscillators, our current strategy also employs a trend filter, the EMA200. As you will see shortly, oscillators are utilized in a non-typical manner.