Stochastic Oscillator: Strategy for Traders

As the Stochastic Oscillator is range-bound, it is also useful for identifying overbought and oversold levels. The stochastic oscillator MTF has some advantages and disadvantages that you should be aware of. It can help you identify the dominant trend and trade with it, as well as avoid false signals and whipsaws with multiple confirmations.

The overbought issue occurs within an uptrend when the main line crosses the 80% level in an upward direction. It’s a sign that the rise slows down, and the price trend reverses Stochastic Oscillator down. Generally, a sell position should be open when the line breaks the 80% level back from the top, where the last closing price is, and follows the downward direction.

Stochastic Oscillator: Guide for Using Indicator & Best Settings

The previous period usually consists of 14 individual periods. Chart 6 shows International Gaming Tech (IGT) with a bullish divergence in February-March 2010. Notice how the stock moved to a new low, but the Stochastic Oscillator formed a higher low. A signal line cross occurs when %K (black) crosses %D (red). The second is a move above 50, which puts prices in the upper half of the Stochastic range. Notice how the Stochastic Oscillator moved above 50 in late March and remained above 50 until late May.

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. In the previous section of the stochastic oscillator tutorial, we covered the different types of Stochastic Oscillators and went through a few basic strategies based on them. However, we did not cover an indicator which can be called a combination of two indicators, which is the Stochastic RSI indicator. In addition to it, we will also cover another indicator, the ATR indicator and learn how it can be used along with a few other popular indicators. As with other indicators, the Stochastic Oscillator also suffers from the problem of false signals.

How to use currency strength meter

The Stochastic indicator, therefore, tells you how close has the price closed to the highest high or the lowest low of a given price range. When your Stochastic is at a high value, it means that the price closed near the top of the range over a certain time period or a number of price candles. If the oscillator moves above 50, the instrument trades within the upper portion of the trading range, with bulls dominating the market. On the contrary, if the oscillator moves below 50, the instrument trades in the lower portion of the trading range, with bears dominating the market. If only there were a market indicator that told us when to buy or sell a stock with precise timing and price accuracy.

Meanwhile, the RSI tracks overbought and oversold levels by measuring the velocity of price movements. The stochastic oscillator is included in most charting tools and can be easily employed in practice. The standard time period used is 14 days, though this can be adjusted to meet specific analytical needs. The stochastic oscillator is calculated by subtracting the low for the period from the current closing price, dividing by the total range for the period, and multiplying by 100. These were some strategies which can be used with the help of the Stochastic indicator. While the stochastic oscillator was a good indicator to identify overbought or oversold levels, the market found it was haphazard, or sloppy to make the readings more meaningful.

How to Identify the Direction (and Strength) of a Trend

They ride the upward trend until the two lines intersect above the overbought level. When you put a stochastic oscillator on a chart, you will see two lines of different colors, the main and signal lines. Ideally, when the two lines are below 20, the pair is said to be oversold and when the lines are above 80, it is said to be overbought. Despite both being used for similar purposes, to identify price trends, they are based on very different theories. The stochastic oscillator is based on the idea that that closing prices will remain near historical closing prices, while the RSI tracks the speed of the trend. This figure indicates that the closing price was extremely near the top of the asset’s 14-period trading range – we’ll go onto what this means in a moment.

• In stock trading, market participants use two contrasting types of analysis.
• For example, when the oscillator indicates bearish divergence, the price may still continue climbing higher for several trading sessions before turning to the downside.
• The stochastic oscillator is calculated by subtracting the low for the period from the current closing price, dividing by the total range for the period, and multiplying by 100.
• Conversely, readings below 20 indicate that the asset is trading near the bottom of its high-low range.

Essentially, the faster %K and slower %D lines are calculated to show the relationship between current and past prices. A bearish divergence occurs when the price records a higher high, but the https://www.bigshotrading.info/blog/morning-star-candlestick-pattern-spotting-reading/ forms a lower high. This signals less upside momentum, potentially indicating a bearish reversal.

Calculating Stochastic Oscillator – Live Market Example

A crossover of the Stochastics above the overbought level or below the oversold level may be more common in a sideways market. On the other hand, a divergence (either positive or negative) between the oscillator and price may be more common during trending markets. It is wise to note that indicators and oscillators are better tools when they are combined with others, including, and especially, the price itself. The strategy involves first identifying overbought and oversold levels using the stochastic oscillator.

In another version of the stochastic strategy on Forex, you should wait for the stochastic to enter overbought or oversold areas to fix profit. First, we add three exponential moving averages with periods of 50-, 100-, and 200-bars. When trading gold, it’s not recommended to use overbought/oversold signals even with a line crossing. You can use slower curves with (21, 7, 7) or (21, 14, 14) settings for daily and weekly charts. Maybe you will succeed and find a perfect combination for your stochastic strategy. The most valuable signal is the third one, which indicates a trend reversal, in some points protects the trader from losing money rapidly.