Bitcoin is rewriting history in terms of valuations, growing two-fold in as little as a month. The tremendous growth in Bitcoin and altcoins has spurred an army of new traders ready to dive into crypto trading. While most traders jump straight into the action, it’s always worthwhile to understand how technical indicators like Stochastic Relative Index (RSI) works. And how it helps you to open positions at the right time.
So, if you’re still curious, you can leverage this indicator to identify market trends. Let’s take a granular look at this technical indicator and its utility in crypto trading.
Stochastic RSI considers the relative strength index (RSI) and applies stochastic oscillator formula to it, deriving market trends that are more sensitive than RSI alone. It is a technical indicator built through the combination of stochastic oscillator formula and relative strength index (RSI) and ranges between 0 to 100.
Stochastic RSI allows traders to identify whether an asset is in the overbought (80) or oversold (20) territory.
Of course, you’re excited to know how it works, but let’s first understand the fundamentals.
Since Stochastic RSI is derived from RSI itself, it makes absolute sense to understand the concept. Basically, the RSI is a technical indicator that tracks an asset’s momentum, identifying whether the cryptocurrency is overbought or oversold.
Typically the RSI is measured between 0 to 100, with values above 70 indicating overbought and values below 30 reflecting oversold positions. The upshot? It represents a signal for the direction and the strength of the trend.
A trader would usually make buy or sell signals based on the RSI crosses of 70 and 30. But if you’re your buying decision relies only on this theory, you’re only going to LOSE MONEY. That’s because the stock market, and not to mention cryptocurrency, never favor the obvious trade.
In fact!
RSI alone gives limited buy or sell signals, missing critical entry or exit points for intraday trading.
On the contrary, Stochastic RSI is more sensitive to market movements, allowing traders to find multiple entry/exit signals. However, it is still critical to combine stochastic RSI with other technical indicators to avoid early/late sell or buy calls.
Stochastic RSI considers the RSI index’s movements within a given period without emphasizing the current price levels. The most popular calculation period is 14 periods (14 days, sessions, hours, or even minutes).
The result is a figure between 0 to 1, swinging with a centerline of 0.5. It is essential to note that some Stoch RSI calculators multiply the output with 100, providing readings in the range of 0 to 100. Another popular calculation period for Stoch RSI is 20 periods.
But, it’s all down to how the calculation. And how you can interpret the readings to identify whether the current RSI value is overbought or oversold.
Stochastic RSI uses RSI as its base. The formula is as shown:
Stoch RSI= (Current RSI – Lowest RSI)/ (Highest RSI – Lowest RSI)
Where:
It is critical to understand that Stoch RSI can be applied to any time frame to identify price movements or market trends. You can use this formula for different trading periods, including days, hours, or even minutes. And they are mostly used to improve sensitivity and generate a more significant number of signals than traditional indicators.
Stochastic RSI takes RSI as its input and applies the stochastic oscillator formula to arrive at a figure between 0 and 1 for any given period.
Below is a pictorial representation of the indicator.
Crypto traders who use Stochastic RSI can select any period and analyze the movement of a crypto asset. We’ll take a more in-depth look into the different ways traders use Stochastic RSI in the coming sections.
But first, you need to understand the complications of the Stochastic and RSI. While they sound similar, but there’s indeed a difference.
So, why do I need a Stochastic RSI indicator when there’s already a Stochastic Oscillator and RSI.
Well, one of the main reasons is because the Stochastic Oscillator formula is the former’s sensitivity. Hence, leading to more buy or sell signals. That means it works best for assets that exist in a volatile market like cryptocurrencies.
In other words, the stochastic oscillator formula works best when the market is trading in a consistent range. But with the combination of RSI to measure the speed of price movements.
If you still think they’re the same, then you’re WRONG!
Here’s the highlights of their differences:
The base of measurement: Stochastic Oscillator uses the closing price of a crypto asset as its base, whereas StochasticRSI uses RSI as its base. It’s imperative to understand that StochasticRSI may lag more than Stochastic Oscillator as it uses RSI as its input.
Measurement scale: Stochastic Oscillator uses a value between 0 and 100 for tracking the market momentum. While, StochasticRSI has a scale of 0 to 1, with 0.5 acting as its centerline.
The number of signals: StochasticRSI is more sensitive to the market movements and provides more oversold/overbought signals than Stochastic Oscillator. A crypto trader needs to know a sign to trade at and which to avoid.
Refers to the chart for the differences between Stochastic and Stochastic.
The main five points to keep in mind are as follow:
While the fundamentals can go on and on, it is most important to understand how to use them.
StochRSI can be used for different occasions, and it’s commonly used to interpret a trading signal.
In this chapter, you’ll learn how to use Stochastic RSI to interpret the trading signals and understand the strategies to apply the indicator strategically.
One of the primary uses of Stochastic RSI is to identify trading signals. Here is how a trader can use StochRSI to interpret the movements of a cryptocurrency.
Since Stochastic RSI allows traders to identify overbought or oversold conditions, it works as an excellent tool for identifying the market momentum.
Traders can use this indicator to:
We are going to present an example using this technical indicator for day trading. This will help you incorporate the principle taught here into your own day trading strategy.
For example:
Assuming you have been trading for several days in a well-defined uptrend, printing Stochastic RSI readings between 50 and 100. The idea is that when the oscillator holds above the 50 levels, the bulls are in control of the market. You can definitely increase the edge of any day trading strategy by going with the trend.
The Stochastic RSI bouncing between the 50 and 100 level is NOT an actionable signal in and of itself. So, we lower our time frame to the 5-minute chart for entry signals. Then, wait for significant oversold signals to time the market.
Since the predominant trend is bullish, any short-term oversold reading can signal the end of a short-term correction and the uptrend’s resurrection.
As we reduce the time frame to time the market, the Stochastic RSI might be prone to many false signals. In this regard, it’s safer to enter the market once the Stochastic RSI bounces from oversold readings and crosses above the 50 levels on the way up. Meanwhile, the protective stop loss level can be safely placed below the lowest low of the bearish pullback.
To increase the odds of a winning trade, you can always combine more than one technique like price action, candlestick patterns, and confirmation from other indicators.
Stochastic RSI has its benefits as well as limitations. Using it in conjunction with other indicators (DMA, support-resistance indicator) could help traders create an effective trading strategy. However, it’s not advisable to use it alone because of higher volatility and distant relation with the current asset prices.