StochRSI is derived by putting RSI values in stochastic formula instead of putting stock price data,thus making the indicator more sensitive to changes in stock price.StochRSI is developed to benefit from both momentum indicators to create more overbought & oversold conditions.
Before going to study stoch-rsi let's see formulae of stochastic & RSI.
Stochastic-
The formula to calculate stochastic oscillator is as below.
%k={C-L14/H14-L14}*100
Where,
C=Previous close
L14=The lowest price traded over previous 14 days.
H14=The highest price traded over previous 14 days.
%K=Value of stochastic.
Stochastic compares the recent close to high & low values of stock over last 14 days.
The basic principle behind stochastic is that, when market is in uptrend, the prices will close near the high & when the market is in downtrend the prices will close near the low.
According to James Lane,the originator of stochastic oscillator, stochastic is momentum indicator.It means it changes the direction before price reversal.The oversold & overbought condition indicates the saturation level that the stock price is going to change the direction.
Relative strength index( RSI)-
RSI is also a momentum indicator.Its formula is-
RSI=100- 100/1+ RS
Where,
RS=average gain/ average loss
Avg.gain is the % of average of gains (white candles) & avg.loss is the % of average of losses(black candles).
Stochastic compares recent close with high & low over 14-periods, while RSI calculates magnitude of strength.
Stochastic RSI-
This indicator is developed by Tushar Chande & Stanely Kroll, written in the book 'The new technical trader'.
As name implies,stochRSI is combination of both stochastic & RSI.
First of all, values of RSI are calculated over 14-day period.These values of RSI are then put into the formula of stochastic.
The formula of stochRSI is as below,
StochRSI =
RSI-RSI(MIN) /RSI(MAX)-RSI(MIN)
Where,
RSI- Recent RSI value.
RSI(MAX)- Highest RSI value over 14-period.
RSI(MIN)-Lowest RSI value over 14-period.
Actually RSI is derived from stock prices & stochRSI is derived from RSI.So stochRSI is called derivative of derivative or indicator of an indicator.
As it is derived from both momentum indicators,it is more sensitive & may produce more overbought & oversold conditions but whipsaws also.So proper care should be taken while using stochRSI.
While using stochastic or RSI,many a times confusion may occur when stochastic or RSI remains in overbought or oversold condition over a prolonged time.The arrangement of stochRSI is to reduce these confusion in the mind of traders.
Oversold & overbought condition-
StochRSI value varies between 0 to 1 or you may take it from 0 to 100 by taking the percentage.
When stochRSI value reaches .2(or 20), it is assumed that the oversold condition is reached.When stochRSI value reaches .8(or 80) it is treated as overbought condition.
StochRSI create more overbought & oversold conditions & that's why risky to trade.The solution for this is to take simple moving average of stochRSI over 10-periods.
- StochRSI gives more opportunity to trade
From the above figure you might understand you can take trade with stochRSI when other indicators don't give any signal.
When stochRSI crosses 50 & moves upward you may take a short term trade which RSI don't show.
Stock is trending in upward direction & RSI is in overbought region but still stochRSI is giving opportunity to trade.
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