The Stochastic RSI (Stoch RSI) is a technical indicator that combines the concepts of the Stochastic oscillator and the Relative Strength Indicator (RSI). It is used to identify overbought and oversold conditions in the market, and to generate trading signals.
The Stoch RSI is calculated by first applying the RSI formula to the asset's closing price, and then applying the Stochastic formula to the resulting RSI values. The Stoch RSI oscillates between 0 and 100, similar to the RSI.
The Stoch RSI is a momentum indicator, which means that it oscillates above and below the zero line. When the Stoch RSI is above 80, it suggests that the asset is overbought and may be due for a correction. When the Stoch RSI is below 20, it suggests that the asset is oversold and may be due for a rebound.
The Stoch RSI can be used in several ways to generate trading signals. One of the most common is to look for overbought and oversold conditions by looking for Stoch RSI values above 80 or below 20. When the Stoch RSI is above 80, it generates a bearish signal, and when it is below 20, it generates a bullish signal.
The Stoch RSI can also be used to identify divergences between the Stoch RSI and price action. When the Stoch RSI is making new highs while price is failing to do so, it can be a bearish divergence and a warning of a potential trend reversal. Similarly, when the Stoch RSI is making new lows while price is failing to do so, it can be a bullish divergence and a warning of a potential trend reversal.
It's important to note that the Stoch RSI is a momentum indicator and it's a lagging indicator, which means that it is based on past price data and may not always provide accurate predictions about future price movements. As with any indicator, it is best to use the Stoch RSI in conjunction with other indicators and analysis techniques to confirm signals and get a better understanding of the market conditions.