What Is Stochastic RSI, and How to Apply It to Crypto Trading?

In cryptocurrency trading, there are a lot of technical indicators you can use to make price predictions. As a trader, once you have mastered the basic indicators, you can start learning about more advanced ones, as adding more tools will only increase the efficiency of predicting future price movements.

 

This article will discuss an advanced derivative of the standard RSI, the Stochastic Relative Strength Index (RSI). We explain everything you need to know about this indicator below. This article can find its calculation, use in the crypto market, the difference between RSI and Stoch RSI, and much more. Let’s take a look!

 

The Stochastic RSI combines two indicators, Stochastic and RSI, to forecast trade entry and exit times based on data collected about an asset or cryptocurrency, which tells about the digital asset's overbought and oversold conditions. The stochastic oscillator formula was created in 1950 by Dr. George Lane, who considered the location of the closing price of an asset to relate it to the low and high range over a specific period.

 

On the other hand, stochastic RSI was first introduced in the book The New Technical Trader, published in 1994 by Tushar Chande and Stanley Kroll. This is a sub-indicator that not only defines the prevailing market trend but also helps us identify the overbought and oversold conditions of the asset. The indicator belongs to the oscillator group, meaning its value falls between 0 and 100 or moves below or above the center line.

 

Stochastic RSI Formula

The formula to calculate STOCHRSI is as follows:

 

Stoch RSI = (Current RSI – Lowest RSI) / (Highest RSI – Lowest RSI)

 

Where:

 

- The Lowest RSI is the reading over the last 14 periods

- The Highest RSI is the reading over the previous 14 periods

 

The ordinary stochastic indicator formula combines the current price and the highest and lowest price levels. However, when the Stochastic oscillator formula is calculated, the formula is applied directly to the RSI instead of the price levels of an asset. Just like simple RSI, the standard settings are based on 14 periods, which can also be changed per your needs. This means that if the formula is applied on a daily chart, it will consider the past 14-day data, and if it is used on a monthly chart, it will consider the past 14-month data.

 

Here's how you can add the Stochastic RSI to the chart on the KuCoin Trading page.

 

Step 1: Choose Indicators

Choose an indicator from the options shown in the chart below.

 

 

Step 2: Search for Stochastic RSI

Type Stochastic RSI in the search bar and the Stochastic RSI indicator will appear on a list of indicators in the search list.

 

 

Step 3: Select Stochastic RSI From Momentum Indicators

Choose the Stochastic RSI from the list of momentum indicators, and it will be automatically applied to your chart.

 

 

The results of stochastic RSI are easy to read as they are similar to the rules of simple RSI. The value of the Stochastic indicator is delivered in a range of 0 and 100 instead of 0 and 1. The center line is drawn at level 50. However, the gauges for overbought or oversold conditions are different. Whenever the value falls over 80, the asset is considered an overbought market; when it falls under 20, it is considered oversold.

 

If the indicator indicates that the asset is going to the oversold zone, the market is generating trading signals for a buy point as the price is likely to surge. On the other hand, if the indicator moves above the overbought zone, it will be interpreted as a short-signal or selling point, as there are more chances that the price will drop ahead.

 

We can also assert divergence points by reading stochastic RSI. You only need to look out for patterns that show different trading signals. For instance, if the line of the stochastic indicator depicts an upward trend and the trend line provides bearish trend signals, it is a divergence. This type of divergence can be found both ways and helps predict that the prevailing market trends might weaken and reverse soon.

 

When the stochastic RSI indicator is applied to a price chart, a white line below the chart represents the %K line. Another red line also appears, which is the 3-period moving average of %K, known as the %D line.

 

Following are the strategies used in cryptocurrency trading with Stochastic RSI to predict the future price momentum of a cryptocurrency.

 

Overbought/Oversold Strategy

This basic strategy defines a trade's entry and exit levels. 

 

Look for cryptocurrency to cross the overbought or oversold levels. This lets you quickly generate the idea of going short or long in the market. 

 

Sell Signal: Overbought Stochastic RSI Indicator

Suppose the Stochastic oscillator indicator shows that the cryptocurrency is overbought, which can also mean that the value of the Stochastic indicator is above 80. In that case, you will want to open a short position in the market.

 

 

Buy Signal: Oversold Stochastic RSI Indicator

If the indicator shows that the cryptocurrency is oversold or the value of the Stoch RSI falls below 20, you can take this as a buy signal.

 

 

However, this can also be a false signal because a cryptocurrency cannot automatically surge in value if the value of the Stoch RSI indicator falls below the 20 levels. Likewise, the cryptocurrency cannot drop in value because the Stochastic indicator moves higher than the 80 level. The levels of stochastic RSI just demonstrate that the periods are only overbought or oversold. Hence, it is recommended not to rely on a single indicator while conducting technical cryptocurrency analysis but to utilize more technical tools.

 

Divergence Strategy

Stochastic RSI is also applied to look out for divergences in the price of a cryptocurrency through another strategy. This strategy is used to see if the cryptocurrency is reaching new high or low levels while the RSI moves in the opposite direction. Such an indicator helps find the signal of a market trend reversal.

 

There are two types of divergences: bullish and bearish. When the cryptocurrency price shows it is making lower lows while the stochastic RSI is touching higher lows simultaneously, it is known as a "bullish divergence." On the other hand, when the cryptocurrency price is making higher high levels while the stochastic RSI is giving lower high levels simultaneously, it is known as "bearish divergence."

 

Hot tip: One important thing to note about using Stochastic RSI to find divergence is that the price might not reverse course after a divergence appears on the chart. You must confirm the divergence through different indicators before placing a bet on the cryptocurrency, as it will only help you conduct a successful trend.

 

Crossover Strategy

You can also use the Stochastic RSI crossover to find strong signals in the crypto market. It is one of the more popular trading strategies as it involves more than just one technical indicator. It also generates stronger signals than the abovementioned strategies. The crossover is said to occur when the two lines cross each other in an overbought or oversold zone.

 

Reading a crossover is relatively easy. We can find a buy signal whenever the surging %K line crosses above the %D line in an oversold zone. Similarly, the sell signal is generated whenever the declining %K line crosses below the %D line in the overbought zone.

 

Another vital thing to notice while looking out for these crossover signals is that they are more effective and reliable when the market is moving within a range. A trending market can weaken the signal effect, so opening trades using these signals in a trending market could be risky.

 

Bull/Bear Strategy

The market setups of bulls and bears can also be found using a stochastic oscillator. It is also one of the most commonly used strategies by cryptocurrency traders. It is similar to the divergence strategy.

 

The setup of a bull trade happens when the Stoch RSI gives higher-high levels, whereas the cryptocurrency price offers lower-high levels. As such, the price could continue to increase because the momentum is also surging. Look out for a short-term pullback in the price of a cryptocurrency and open a buy trade in the market when the Stoch RSI drops below 50 but moves higher after that.

 

If we talk about the setup of a bear trade, it can happen when the Stochastic oscillator gives lower levels, whereas the cryptocurrency price offers higher levels. It shows increased selling pressure in the market, and cryptocurrency's price might plummet. In such a situation, you can open a sell trade to benefit from the declining prices.

 

We recommend using different technical tools to confirm the trade signals you generate from Stochastic RSI, as it can also create false signals.

 

In conclusion, the Stochastic RSI is a valuable technical indicator for crypto trading, offering increased sensitivity and speed compared to the traditional RSI. This makes it particularly well-suited if you seek robust signals in the highly volatile cryptocurrency market. However, relying solely on one indicator is not advisable; combining Stochastic RSI with other technical tools can generate even more reliable trade signals.

 

As the cryptocurrency market continues to gain traction, traders are increasingly interested in leveraging multiple technical indicators to navigate this high-risk environment. Incorporating Stochastic RSI into their analytical toolkit can help capitalize on stronger signals and maximize profits. Common strategies utilizing the Stochastic oscillator include divergence, crossover, and bull/bear tactics, frequently employed in the crypto market.

 

Furthermore, it can enhance its effectiveness by integrating Stochastic RSI with additional technical indicators, such as trend lines and price formations like wedges and triangles. Applying these tools to the price chart allows you to establish valid trend lines, anticipate price breaks, and use Stochastic RSI confirmations to make informed trading decisions.