That said, StochRSI is a momentum oscillator that measures the level of RSI relative to its range, over a set period of time. It's an indicator developed by Tushard Chande and Stanley Kroll, which uses RSI as the foundation and applies to it the formula behind Stochastics.

When calculating StochRSI, we consider two main parameters: the high-low range and the number of periods used for the calculation. The former represents the magnitude of changes in the security's price over time, while the latter indicates how frequently these changes occur. When RSI records a new low or high for the period, StochRSI will be at 0 or 100 respectively.

A reading of .20 would mean that the current RSI was 20% above its lowest level or 80% below its highest level, indicating an overbought situation. Conversely, a reading of .80 would mean that the current RSI was 80% above its lowest level or 20% below its highest level, indicating an oversold situation.

Signals Overbought and Oversold Crossovers

If an uptrend has been identified in the underlying security, then a buy signal would be generated when StochRSI advances from oversold (below .20) to above .20. Conversely, if a downtrend has been identified, then a sell signal would be generated when StochRSI declines from overbought (above .80) to below .80.

Centerline Crossovers

Some traders look for moves above or below .50 (the centerline) to confirm signals and reduce whipsaws. A move from oversold to above .50 could constitute a buy signal and would remain in place until a decline below .50. Conversely, a move from overbought to below .50 would act as a sell signal that would remain in place until an advance back above .50.

StockCharts.com - StochRSI

StockCharts.com provides an interactive version of StochRSI on their website, allowing users to visualize the indicator's performance in real-time. By analyzing the chart, traders can identify potential buy or sell signals and make informed decisions about their investments.

Positive and Negative Divergences

A positive divergence followed by a confirming advance above .20 could constitute a buy signal and a negative divergence followed by a decline below .80 could act as a sell signal. Failures occur when moves back past the trigger lines would indicate a failed signal. An advance back above .80 would indicate a failed signal, while a quick move below .20 could indicate the beginning of a strong downtrend.

Strong Trend

As with many oscillators, StochRSI can become overbought (or oversold) and remain overbought (or oversold) for an extended period. A move above .80 may imply overbought, but it can also indicate a strong up trend and remain above .80 for a prolonged period.

Example

In the WorldCom example above, the stock peaked in June-99 and was in a well-established downtrend. A series of lower lows and lower highs confirmed the primary trend as bearish. According to Chande and Kroll, these conditions would best suit StochRSI for identifying overbought levels from which to short the stock. Each time StochRSI advances above .80, an overbought situation would occur. When the indicator declined from its overbought level back below .80, a sell signal would have been given.

Conclusion

StochRSI is a useful tool for traders looking to identify potential buy or sell signals in the stock market. By analyzing the indicator's performance and considering various factors such as volatility drag, trading strategies, and risk management, traders can make informed decisions about their investments.