Most technical analysis indicators are invented independently. However, there are also many indicators built on the foundation of other indicators, including the Stochastic RSI indicator. It is one of the important technical analysis tools trusted by traders. Therefore, this Crypto Trading article will provide detailed information about this indicator and how to apply it most effectively.
Overview of what you need to know about Stochastic RSI indicator
Stochastic RSI indicator developed from the RSI indicator and is mainly used to identify oversold and overbought conditions of the market, to help investors determine market trends.
Definition of stochastic RSI
The Stochastic RSI indicator is a technical indicator used to assess the degree of deviation of an asset from the general trend. It measures the relationship between the current closing price and the price range over a given period of time, usually 14 days.
This indicator ranges from 0 to 1 or 0 to 100. It is created by applying the Stochastic Oscillator formula to the Relative Strength Index (RSI). So it can be considered as a derivative of the RSI.
Stochastic RSI was first introduced in 1994. It has since become a popular tool used by traders.
In addition, Stochastic RSI when combined with Bollinger bands and RSI, investors can build more effective trading strategies by taking advantage of trend confirmation signals and price fluctuations.
Meaning of Stochastic RSI indicator in technical analysis
To increase the winning rate in trading, investors need to understand the meaning and how it works. Understanding the meaning and how to use the Stochastic RSI indicator effectively will help investors make more accurate trading decisions. Specifically, Stochastic RSI helps:
Identify overbought and oversold zones using indicators
Stochastic RSI is an oscillating indicator, whose value ranges from 0 to 100. This makes Stochastic RSI a useful tool for identifying overbought (when above 80) and oversold (when below 20) areas in the market.
Stochastic RSI crossing these levels does not always signal a trend reversal. In the case of strong price trends, the market can remain overbought or oversold for a long time.
Reversal signal from Stochastic RSI
The Stochastic RSI chart typically displays two indicator lines:
- %K will reflect the real value of the Stochastic RSI indicator
- %D is the moving average of %K.
When the market is trending strongly, the crossover of these two lines is considered a signal that a reversal may be taking place. Using the %K and %D crossover signal from this indicator can help investors determine effective entry points.
See more: What is so important about RSI that investors?
Stochastic RSI indicator calculation formula
The RSI calculation formula is as follows:
- Stoch RSI is calculated = (Current RSI – Lowest RSI) / (Highest RSI – Lowest RSI)
In there:
- Current RSI: RSI value at the current moment
- RSI Low: the lowest RSI value in a recent period (usually 14 sessions)
- RSI High: the highest RSI value during that same period
Basic usage of Stochastic RSI indicator
The purpose of developing Stochastic RSI is to improve the number of signals compared to traditional indicators. It tends to move faster and provides more signals. Traders often use RSI to:
Using stochastic RSI to determine market trends
The RSI (Relative Strength Index) indicator can provide signals about the future trend of the market:
Uptrend:
- When the RSI line crosses the 50 level from bottom to top
- When the RSI line is in the 40-60 range and suddenly crosses the 60 threshold
Downtrend:
- When the RSI line crosses the 50 level from top to bottom
- When the RSI line is in the 40-60 range and suddenly drops below 40
These signals cannot accurately determine entry and exit points. Determining the general trend is still useful. Investors can combine RSI with other indicators such as Trendline, MA, and MACD to make more effective trading judgments and decisions.
Use the Stochastic indicator to identify overbought and oversold levels
A fairly effective new trading strategy is to use only the “overbought” and “oversold” signals from the RSI indicator. When the RSI goes above 70, the market is considered “overbought” and selling can be considered. Conversely, when the RSI falls below 30, the market is considered “oversold” and buying can be considered.
To improve efficiency, it is recommended to combine RSI signals with other indicators such as Trendline, MA, and MACD. Filtering noise signals by using many different analysis tools at the same time will help improve the accuracy and efficiency of the trading strategy.
Using the Stochastic RSI indicator as a divergence signal
Combining the use of the RSI indicator with some other indicators such as Momentum, MA, and MACD can identify divergence signals. From there, they can predict when the price will tend to reverse:
Top Divergence:
Although the market price is higher than the previous high, the RSI indicator is lower than the previous high RSI level. This is a signal that the uptrend may be over. Investors can consider opening a short position at this point.
Bottom Divergence:
When the market price is lower than the previous low, the RSI indicator is higher than the previous low RSI. This is considered a signal that the downtrend may be ending. At this point, it is possible to consider opening a buy (long) position at this time.
Closed divergence:
In addition to the cases of top and bottom divergence, there is another type of divergence called “hidden divergence”. This is a situation when the trendline of the market price is not in the same direction as the trendline of the RSI indicator:
- Price goes up but RSI goes sideways
- Price goes down but RSI goes sideways
- Price is sideways but RSI is down
- Price is sideways but RSI is going up
Advantages and disadvantages of using Stochastic indicators in crypto trading
RSI is a fairly sharp analytical tool and provides effective judgments. Let’s review the advantages and disadvantages of using this tool:
Advantage
The Stochastic RSI indicator provides more buy and sell signals than the regular RSI indicator, due to its higher sensitivity. This indicator is designed to predict price extremes before the RSI reaches extreme values. If used correctly, it can identify more potential trading opportunities.
Traders can plan their daily strategies. Stochastic RSI can also help determine market momentum. This allows them to proactively prepare appropriate strategies.
Stochastic RSI can also help swing traders identify short-term price corrections and bullish trends. The main idea is to take advantage of short-term price fluctuations of crypto assets.
Defect
One major limitation of the Stochastic RSI indicator is that it tends to react quite quickly. It moves from high to low and vice versa easily. Many traders will use additional 5 or 10-day MAs to smooth out this indicator, making the signal more stable.
Stochastic RSI is also considered a secondary derivative of price. It is based on the RSI indicator which is a primary derivative. This means that the output of Stochastic RSI reflects the value of another indicator, not the direct market price. Therefore, sometimes the signal from Stochastic RSI may not be completely synchronized with the actual movement of the asset price.
See more: OKX: open an OKX account – Reputable crypto exchange
Epilogue
The Stochastic RSI indicator can be a very effective trading indicator. Hopefully, through this article on Crypto Trading, traders can better understand Stochastic RSI. And don’t forget to use this knowledge to make accurate investment decisions, bringing the best profits.
Frequently Asked Questions
What are the important meanings of the Stochastic RSI indicator?
Stochastic RSI has the following meanings: Identifying overbought and oversold zones and providing reversal signals.
How to calculate Stochastic RSI?
The calculation formula is as follows:
- Stochastic RSI = (Current RSI – Lowest RSI for the period) / (Highest RSI for the period – Lowest RSI for the period)
How to use Stochastic RSI effectively?
To effectively use Stochastic RSI, investors need to pay attention to some key indicator levels:
- Overbought zone
- Oversold zone
- Stochastic RSI Divergence
