Understanding Stochastic Oscillator

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The red line marks the lowest price of the previous three candles, which is 1,17948. A sell signal is formed when the main momentum indicator line crosses the signal line upside-down. If it happens in the overbought zone, it’s a signal of a short position. If it is in the oversold area, you should open a long trade to avoid losing money rapidly.

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In other words, the RSI was designed to measure the speed of price movements, while the stochastic oscillator formula works best in consistent trading ranges. In technical analysis of securities trading, the stochastic oscillator is a momentum indicator that uses support and resistance levels. The term stochastic refers to the point of a current price in relation to its price range over a period of time. This method attempts to predict price turning points by comparing the closing price of a security to its price range. An overbought level is indicated when the stochastic reading is above 80.

Bull and bear set-ups

They are included in the classic technical analysis and remain popular among plenty of traders. Let’s take a look at the strategy of Bollinger bands and stochastic oscillators through an example. A stop-loss is set with a small shift from the extreme point of the breakout bar. The ideal take profit level is at the opposite band of the Bollinger indicator.

  • A fast stochastic oscillator is a momentum indicator that reacts to the market movements faster than other types.
  • In this way, the stochastic oscillator can foreshadow reversals when the indicator reveals bullish or bearish divergences.
  • 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.
  • A divergence between the most recent closing price and curves’ direction is also a reversal signal.
  • On the bearish side, only readings of 15 and below are interpreted as signaling oversold conditions.

A trader could enter the market once the %K fell below the %D . The crossover signal will be discussed in the next section. The take-profit target could be placed on the nearest support level .

Band Buy Triggers

However, these are not always indicative of impending reversal; very strong trends can maintain overbought or oversold conditions for an extended period. Instead, traders should look to changes in the stochastic oscillator for clues about future trend shifts. The stochastic oscillator is a technical analysis momentum indicator used by traders to determine momentum based on a particular asset’s price history.


Therefore, it is best used along with other technical signifiers rather than as a standalone source of trading indicators. An instrument won’t necessarily fall in price just because it is overbought. Similarly, it won’t automatically rise because it is oversold. Overbought and oversold merely mean the price is trading near the top or bottom of the range for the specified time period.

How Do You Read the Stochastic Oscillator?

https://business-oppurtunities.com/ called the stochastic oscillator because the lines move up and down in a wave-like motion—always bound between zero and 100. %D is a moving average of %K readings, typically over the last three periods. Most electronic trading platforms will do the stochastic math for you, but it’s generally a good thing to know the formula so you can understand the “why” behind the indicator. Fast Stochastics produce early signals, meaning that a further smoothing of the %K and %D lines is preferred by many traders. To use the stochastic oscillator, it is first important to understand exactly what the readings are showing you.

The image below shows the behavior of the Stochastic within a long uptrend and a downtrend. In both cases, the Stochastic entered “overbought” , “oversold” and stayed there for quite some time, while the trends kept on going. You just check the total distance of the range between the highest high and the lowest low. And then all you do is see how close the price is closing to the highest high or the lowest low.

The stochastic oscillator represents recent prices on a scale of 0 to 100, with 0 representing the lower limits of the recent time period and 100 representing the upper limit. A stochastic indicator reading above 80 indicates that the asset is trading near the top of its range, and a reading below 20 shows that it is near the bottom of its range. The primary limitation of the stochastic oscillator is that it has been known to produce false signals.

Stochastics are most effective in broad trading ranges or slow moving trends. Two lines are graphed, the fast oscillating %K and a moving average of %K, commonly referred to as %D. As with most other technical analysis trading tools, this momentum indicator has its unique benefits and drawbacks.

Reversal candlestick patterns and chart patterns, such as triangles and “Head and Shoulders,” are the best for signal confirmation. It’s highly recommended to implement the stochastic oscillator with other trend indicators. Take time to learn more about the trading strategy of stochastic with Bollinger Bands.

Stop loss is set at the extreme of the local minimum of 3-5 previous candles. The take profit is placed at a distance of the stop-loss or more in 5-10 points. To implement the technical indicator in the chart, press “Indicators” and choose “Stochastic Oscillator” from the dropdown list.

Readings above 50 suggest the asset is trading among the upper section of the trading range. Readings below 50 signal that the asset is trading in the lower part of the trading range. The benefit of having an indicator on your chart is that it adds an objective confluence factor to your decision-making.

Before looking at some chart examples, it is important to note that overbought readings are not necessarily bearish. Securities can become overbought and remain overbought during a strong uptrend. Closing levels that are consistently near the top of the range indicate sustained buying pressure.

Was following wrong path of buy or using offline advertising methods when overbought/oversold. Now unlike chart or candlestick patterns where the entry can be subjective, the Stochastic indicator doesn’t give you that problem. You’ve learned the 2 biggest mistakes traders make when using Stochastic and how to avoid it.

How this indicator works

How you respond to an asset that enters the oscillator’s overbought or oversold territories depends wholly on your outlook (short-term or long-term) and your strategy. Technical trade indicators are mathematical calculations that leverage historical price and volume data to forecast future price trends of cryptocurrencies. These metrics serve as a crucial tool in the arsenal of cryptocurrency traders, offering a systematic approach to analyzing market behavior and informing strategic decision-making.

A moving average is a great tool to use in conjunction with stochastics. It will act as a filter for your signals, as long as your trades are in the direction of the moving average. When the price is below the moving average, only look for shorts. In the image below, the blue line is the fast stochastic%K line. The red linesignalline is a 3-period moving average of %K, referred to as the slow stochastic%D line.

Its sensitivity to market movements is reducible by adjusting that time period or taking a moving average of the result. It can be used to generate overbought and oversold trading signals in shares, indices, currencies, and many other investment assets utilizing a 0–100 bounded range of values. Typically, the stochastic indicator is employed by experienced traders and those learning technical analysis. A stochastic oscillator is a momentum indicator comparing a particular closing price of a security to a range of its prices over a certain period of time.

The information in this site does not contain investment advice or an investment recommendation, or an offer of or solicitation for transaction in any financial instrument. Discover the range of markets and learn how they work – with IG Academy’s online course. The material provided is for information purposes only and should not be considered as investment advice. As the price formed two candles with long upper shadows before a reversal, a stop-loss order would be placed above the shadows . Over time, you will learn to use the Stochastic indicator to fit your own personal trading style. This simple momentum oscillator was created by George Lanein the late 1950s.

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