Stochastic RSI (StochRSI) – Rules, Settings, Strategy, Returns (78% Win Rate)

For swing traders, oscillators are not just valuable tools for market analysis but also a way to track the individual price swings they intend to trade, and which oscillator does it better than one that combines stochastic with RSI — Stochastic RSI (StochRSI). What do you know about this indicator?

The stochastic RSI (StochRSI) is a technical indicator created by applying the stochastic concept to the relative strength index (RSI) data rather than the price data. It measures the level of the current RSI value relative to its high-low range over a chosen period. The StochRSI offers a more sensitive assessment of the momentum of price movements and overbought or oversold conditions in the market compared to RSI.

In this post, we will take a look at most of the questions you may have about the Stochastic RSI: what it is, how it works, and how you can use it to improve your trading strategies. Read on!

Key takeaways

What It Is:

• The Stochastic RSI (StochRSI) applies the stochastic oscillator formula to RSI values instead of price data.
• It’s designed to give a more sensitive measure of momentum and overbought/oversold conditions than the traditional RSI.

Purpose:

• Developed to enhance RSI’s sensitivity and generate more frequent and timely signals.

Origins:

• Created by Tushar Chande and Stanley Kroll and introduced in their 1994 book “The New Technical Trader.”

How It Works:

• Values range between 0 and 1 (or 0 to 100 if scaled).
• Overbought levels are typically above 0.8 (or 80).
• Oversold levels are typically below 0.2 (or 20).
• This differs from RSI’s typical 70/30 thresholds.

Trading Applications:

• Used to:
  • Track price swings.
  • Gauge momentum.
  • Identify overbought/oversold conditions.
  • Spot divergences for potential trend reversals.

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What is the Stochastic RSI indicator?

The stochastic RSI (StochRSI) is a technical indicator created by applying the stochastic concept to the relative strength index (RSI) data rather than the price data. It measures the level of the current RSI value relative to its high-low range over a chosen period. The StochRSI offers a more sensitive assessment of the momentum of price movements and overbought or oversold conditions in the market compared to RSI.

Developed by Tushar Chande and Stanley Kroll, the StochRSI was introduced to the trading public in their 1994 book, “The New Technical Trader.” The authors just wanted to improve the sensitivity of the traditional RSI to overbought and oversold market conditions so as to generate more frequent and timely trading signals. (However, we believe it was first published in Technical Analysis of Stocks and Commodities.)

The indicator’s values range from 0 to 1, with values above 0.8 usually considered overbought and values below 0.2 considered oversold. In some versions, the values are multiplied by 100 to have values that range from 0 to 100, with values above 80 as overbought and values below 20 as oversold. Compare this to the traditional RSI’s 70 and 30 thresholds for overbought and oversold levels respectively.

As with other momentum oscillators, traders use it to track individual price swings, assess market momentum, identify overbought and oversold conditions, and study divergences between price and the indicator for anticipating potential trend reversals.

Below is an example of how the indicator might look on a chart:

StochRSI trading strategy- rules, settings, returns, and performance

Let’s backtest a trading strategy that uses the StochRSI – complete with trading rules and settings.

We make the following trading rules:

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

Commissions and slippage of 0.03% per trade are included.

This is the equity curve for S&P 500 from 1993 until today:

The strategy has 228 trades, and the average gain per trade is 0.7%. The win rate is 78%, and the max drawdown is a moderate 15%. The strategy is invested 10% of the time but still manages an annual return of 4.85%.

We backtested many assets and found that the stochastic RSI indicator works best for stocks.

StochRSI trading strategy – complete code

The Amibroker code for the backtest looks like this:

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

How does StochRSI differ from traditional RSI?

The StochRSI differs from traditional RSI in that the latter is calculated from the price data, whereas the former is calculated from RSI itself. In other words, the StochRSI is obtained by applying the stochastic formula on the RSI data over a chosen period, while the RSI is obtained from the ratio of price gains to price losses over a chosen period.

Given its method of calculation, the StochRSI is more sensitive to momentum changes in the market and moves more quickly from overbought to oversold, or vice versa, than the traditional RSI. As a result, the StochRSI gives signals more frequently than RSI.

Unlike the traditional RSI whose values range from zero to 100, with 70 and 30 thresholds for overbought and oversold levels respectively, the StochRSI’s values range from 0 to 1, with values above 0.8 usually considered overbought and values below 0.2 considered oversold.

However, on some trading platforms, the values are multiplied by 100 to have values that range from 0 to 100, with values above 80 considered overbought and values below 20 considered oversold.

Why use Stochastic RSI in trading?

You use Stochastic RSI in trading because it offers a more sensitive assessment of the momentum of price movements. The indicator moves faster to the overbought or oversold regions compared to RSI and, as such, can generate signals more frequently. When the indicator rises into the overbought region and falls back below it, it could be a sell signal if the market is in a downtrend.

Likewise, when the indicator falls to the oversold region and rises back above the 0.2 or 20% threshold, it could be a buy signal if the market is in an uptrend. Apart from the oversold and overbought signals, you can also use the divergence signals to anticipate price reversals and trade accordingly.

How is StochRSI calculated?

The StochRSI is calculated by applying the stochastic formula to the RSI data. The formula is given as follows:

StochRSI = (RSI_c — Lowest RSI) / (Highest RSI — Lowest RSI)

Where:

RSI_c = Current RSI value

Lowest RSI = the lowest RSI value over the chosen period (N)

Highest RSI = the highest RSI value over the chosen period (N)

K value of StochRSI = 3-period SMA of StochRSI

D value of StochRSI = 3-period SMA of K

The calculation of the indicator follows these steps:

1. Calculate the n-period RSI values as price data are posted for every price bar.
2. Use the RSI data to calculate the StochRSI over N periods.
3. Get a 3-period SMA of the StochRSI to get the K plot.
4. Compute a 3-period SMA of the K plot to get the D plot.

What are the key components of Stochastic RSI?

The key components of Stochastic RSI include:

• The RSI data: The Stochastic RSI is calculated from the RSI data of a given period, usually 14 periods. So, you have to first get the 14-period RSI data continuously as the price bars are printed. That’s the data to use to compute the StochRSI.
• The K plot: This is the faster line of the Stochastic RSI indicator. It is a 3-period SMA smoothing of the StochRSI computed from the RSI data.
• The D plot: This is the slow line of the Stochastic RSI indicator. It is a 3-period SMA smoothing of the K plot. It serves as the signal line. The K-Line crossing above it is bullish, while crossing below it is bearish.

How to interpret Stochastic RSI signals?

To interpret Stochastic RSI signals, you have to consider the position of the indicator and whether the K Line has crossed the D Line. When the indicator crosses above the 0.8 or 80% level, the market is said to be overbought.

The K Line crossing below the D Line and falling below that level suggests a potential bearish price reversal. Also, a bearish divergence — when the price is making a higher high but the indicator is making a lower high or vice versa — signals a potential downward reversal.

Conversely, when the indicator crosses below the 0.2 or 20% level, the market is said to be oversold. The K Line crossing above the D Line and rising above that 0.2 level suggests a potential bullish price reversal. Also, a bullish divergence — when the price is making a lower low but the indicator is making a higher low or vice versa — signals a potential upside reversal.

What are the best settings for StochRSI?

The best settings for StochRSI will depend on your trading strategy and the market you are trading. Generally, the default settings for the indicator on TradingView are 14 periods for the RSI length, 14 periods for the StochRSI length, 3 periods for the K Line, and 3 periods for the D Line.

However, you can change the settings to whatever you want. You will have to backtest your strategy on the market you intend to trade to find out the best setting for you.

How to add Stochastic RSI to your chart?

To add Stochastic RSI to your chart, go to the indicator section of your trading platform to search for the indicator. Double-click on it and drag it to your chart. A box will pop up for you to input your preferred settings, as in the chart below:

If the indicator is not preinstalled on your trading platform, you can get a programmer to code a custom version for your trading platform. You will have to install it first before you can attach it to your chart.

When should you use StochRSI in trading?

When you use StochRSI in trading will depend on your trading style and strategy. However, the indicator is best used for trading individual price swings, whether it is in day trading or swing trading.

For instance, you may want to trade the individual impulse swings in the trend direction. In that case, you can use a moving average or trendline to find the trend direction and then use the StochRSI to find entry points in that direction after a pullback to a key level. In an uptrend, you can look for buy setups when the price pulls back to a support level and the StochRSI forms an oversold signal or a bullish divergence signal.

What are the advantages of using Stochastic RSI?

The advantages of using Stochastic RSI include:

• The StochRSI is more sensitive to price changes than the traditional RSI, and as such, it offers more timely signals.
• It shows when the market is in an overbought or oversold condition.
• It can generate different types of entry signals, such as the overbought/oversold signal and divergence signal.
• You can combine it with other indicators or analysis tools to create robust trading strategies.

What are the limitations of StochRSI?

The limitations of StochRSI include:

• It can be very sensitive, which means that it can give a lot of false signals in volatile markets
• You may need to combine it with other indicators to get the best out of it.
• Using it as a standalone trading strategy may lead to too many false signals
• It cannot show the direction of the main trend and, as such, puts you at risk of trading against the trend.

How to combine Stochastic RSI with other indicators?

To combine Stochastic RSI with other indicators, you have to choose indicators that can complement its functions. Since it is a momentum oscillator, it is best to combine it with trend indicators, such as moving averages.

The moving average will show you the direction of the trend, while you use the StochRSI to track the individual price swings and spot good entries at the emergence of new impulse swings in the trend direction.

What are common Stochastic RSI trading strategies?

Common Stochastic RSI trading strategies include:

• Trend-continuation swing trades: These are trades that aim to profit from impulse price swings in the trend direction. The idea is to wait for a pullback to a key level and then use the StochRSI overbought/oversold signal or divergence to anticipate the end of the pullback so you can hop in at the beginning of the next impulse swing.
• Mean-reversion trades: These are trades that try to ride the price back to its mean after it has deviated significantly from it. This strategy is best used in range-bound markets. The oversold signal or bullish divergence at the support level of the range can be a buy signal, while the overbought signal or bearish divergence at the resistance level can be a sell signal.

How to identify overbought and oversold conditions with StochRSI?

To identify overbought and oversold conditions with StochRSI, you check whether the indicator has crossed the relevant threshold. The threshold for overbought is 0.8 or 80%, and that of oversold is 0.2 or 20%.

When the indicator crosses above the 0.8 or 80% level, the market is said to be in an overbought condition. Likewise, when the indicator crosses below the 0.2 or 20% level, the market is said to be in an oversold condition.

Can Stochastic RSI predict market reversals?

Yes, the Stochastic RSI can predict market reversals via its divergence and oversold/overbought signals. For instance, a bullish divergence, which occurs when the price is making a lower low but the indicator is making a higher low or vice versa, could predict an upward reversal in a downtrend.

Similarly, a bearish divergence, which occurs when the price is making a higher high but the indicator is making a lower high or vice versa, could predict a downward reversal in an uptrend.

How to use StochRSI for trend confirmation?

To use StochRSI for trend confirmation, you have to do a multi-timeframe analysis since the indicator is a momentum oscillator that only tracks individual price swings and not a trend indicator.

A price swing on a higher timeframe (say the daily timeframe) can be a trend on a lower timeframe (say the 30-minute timeframe). So, with a multi-timeframe analysis, you can use the StochRSI to identify a price swing on the daily timeframe, which would be the trend on the 30-minute timeframe.

What timeframes work best with Stochastic RSI?

The timeframes that work best with Stochastic RSI will depend on your trading style and backtesting result. If you are a swing trader, you may focus on daily, 8-hourly, and 4-hourly timeframes.

However, to know the particular timeframe that works best for swing trading, you will have to backtest your strategy on the various timeframes to find out. The same is true if you are day trading and want to know which of the hourly, 30-minute, or 15-minute timeframe is best for you.

How to adjust Stochastic RSI for different markets?

To adjust Stochastic RSI for different markets, you will have to backtest the indicator on the different markets to know the settings and parameters that work best for each market.

Then, you set the indicator with the specific parameters for each market when trading markets. In other words, when trading any market, you only set the parameters that are specific to that market.

What are the common mistakes when using StochRSI?

The common mistakes when using StochRSI include:

• Making the indicator a standalone strategy, which may expose you to trading against the trend
• Trading without a reliable strategy with clear entry and exit criteria
• Not combining it with other indicators to know when the market is trending
• Not backtesting your strategy to be sure it has an edge in the market
• Trading without a risk management plan.

How to backtest a Stochastic RSI strategy?

To backtest a Stochastic RSI strategy, you can follow these steps:

1. Study the markets you want to backest your Stochastic RSI strategy.
2. Create the Stochastic RSI strategy that you want to backtest and state the parameters to test.
3. Gather the historical data you need for the backtesting and divide the data into in-sample and out-of-sample data.
4. Code the strategy into a trading algorithm.
5. Run your backtesting on the in-sample data and optimize with the out-of-sample data, adjusting your parameters as needed.
6. Evaluate the results of your backtesting

What are the differences between StochRSI and MACD?

The differences between StochRSI and MACD include:

• The StochRSI is calculated by applying the stochastic formula to RSI data, while the MACD is calculated as the difference between a 26-period EMA and a 12-period EMA.
• The StochRSI’s values range from 0 to 1 or 0% to 100%, but the MACD has no range of values as its values go from negative to positive without any upper or lower limit.
• While both can give divergence signals, the StochRSI can produce overbought (above 0.8 or 80%) and oversold (below 0.2 or 20%) signals, but the MACD does not have an overbought/oversold threshold.

How to use Stochastic RSI in Forex trading?

To use Stochastic RSI in Forex trading, you can combine it with other indicators, such as moving averages and support/resistance levels, to create a reliable trading strategy. Then, you backtest the strategy on different currency pairs to know where it works best and trade it on that pair.

Can StochRSI be used for day trading?

Yes, the StochRSI can be used for day trading if you create a profitable day trading strategy with it and trade it on the right timeframe. Your strategy can be to trade in the direction of the trend after a pullback or trade reversal swings in a range-bound market.

Whatever it is, backtest it on intraday timeframes to be sure it has an edge in the market you are trading.

How does Stochastic RSI enhance your trading strategy?

The Stochastic RSI enhances your trading strategy by providing you with early entry setups for swing reversals in a range market and trend-continuation impulse swings after a pullback.

You can use it for the entry setup for your trading strategy.

Where to learn more about Stochastic RSI?

You can learn more about Stochastic RSI from this trading blog or other trading blogs, like therobusttrader.com and quantifiedstrategies.com.

Another place to learn more about the indicator is in the book, “The New Technical Trader” by Tushar Chande and Stanley Kroll.