What is the 'StochRSI'

The StochRSI is an indicator used in technical analysis that ranges between zero and one and is created by applying the Stochastic Oscillator formula to a set of Relative Strength Index (RSI) values rather than standard price data. Using RSI values within the Stochastic formula gives traders an idea of whether the current RSI value is overbought or oversold - a measure that becomes specifically useful when the RSI value is confined between its signal levels of 20 and 80.

BREAKING DOWN 'StochRSI'

The StochRSI was developed by Tushar Chande and Stanley Kroll and detailed in the book The New Technical Trader published in 1994. While technical indicators already existed to show overbought and oversold levels, the two developed StochRSI to improve sensitivity and generate a greater number of signals than traditional indicators.

The StochRSI is calculated using the following formula:

StochRSI = (RSI - Lowest Low RSI) / (Highest High RSI - Lowest Low RSI)

Using the StochRSI

The StochRSI is a second derivative of price, which means that it doesn't always look similar to the price. The indicator deemed to be oversold when the value drops below 0.20, meaning the RSI value is trading at the lower end of its predefined range, and that the short-term direction of the underlying security may be nearing a correction. Conversely, a reading above 0.80 suggests the RSI may be reaching extreme levels and could be used to signal a pullback in the underlying security.

In addition, the StochRSI can be used to identify short-term trends by looking at it in the context of an oscillator with a centerline at 0.50. When the StochRSI is above 0.50, the security may be seen as trending higher and vice versa when it's below 0.50. The downside to using the StochRSI for these reasons is that it tends to be quite volatile, which means that some smoothing may be needed. Some traders will take a moving average of the StochRSI to reduce the volatility and make the indicator more useful. For example, a 10-day simple moving average of the StochRSI can produce an indicator that's much smoother and more stable.

Of course, the StochRSI should also be used in conjunction with other technical indicators or chart patterns to maximize effectiveness, especially given the high number of signals that it generates. Non-momentum oscillators, such as the Accumulation Distribution Line, may be particularly helpful because they don't overlap in terms of functionality and provide additional insights.

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