Stochastic Oscillator for Technical Analysis: How to Use and Read

Traders need to always keep in mind that the oscillator is primarily designed to measure the strength or weakness – not the trend or direction – of price action movement in a market. Some traders tend to pay close attention to crossovers at the 50 level (that is, when the %K line crosses the 50 line on the stochastic scale). Conversely, when the oscillator moves below 20, and the https://www.bigshotrading.info/stock-market-basics/ two indicator lines cross while still under the 20 level, this is an oversold buy signal. A stochastic reading is a percentage expression of a security’s trading range within a given period. Similarly, the oversold line depicts price levels that fit within the bottom 20% of recent price movements. Multiply the readings by 100 to go from percentage terms to a scale of zero to 100.

Ignore the fact that there is a different indicator in the article. The stochastic oscillator follows the classic rules of the technical analysis for bullish and bearish divergence and convergence. Using the stochastic oscillator on the chart, blue squares indicate overbought areas; red ones mark oversold zones. In all three cases, those major signals show that the price tends finally to be reversed. It corresponds with the area on the graph marked with a blue oval.

History of the stochastic oscillator

This divergence coupled with a trendline break in the price of gold may have acted as a strong warning to futures traders. The Stochastic technical analysis indicator might be helpful in detecting price divergences and confirming trends. A trader might interpret a sell signal when the Stochastic is above the 80 overbought line and the %K line crosses below the %D line, sell. The Stochastic technical analysis indicator might be helpful in detecting price divergences and confirming trend. How you choose to use the stochastic oscillator will depend on your personal preferences, trading style, and what you hope to achieve. Stochastic can be used in short-term trading like scalping and day trading, and in swing trading in combination with pivot points.

Can also select the line’s value, line thickness, value and visual type (dashes is the default). This tool is handy for trend-following when there are strong trends in the market and will help you get in on a trend early and stick with the trend for maximum profits. Some day-trading and scalping systems use one stochastic line (the faster one, in most instances). However, this would not allow for detecting stochastic crossovers, which requires both lines, also known as a “Full stochastic”. Traders should not enter trades blindly based simply on OB/OS conditions alone.

What Are the Advantages of the Stochastic Oscillator?

Remember to not place too much faith in oversold/overbought readings when the market is trending. Again, oscillators will trigger more false signals if a stock is trending. This bullish divergence may have warned traders to exit their shortsells, traders may have interpreted that the price of gold had a strong potential of bottoming.

• If the primary curve forms an acute angle, the following price movement will be intense.
• The stochastic in technical analysis is a momentum indicator, which means that it doesn’t reflect a trend like common trend tools, like moving averages.
• The indicator can also be used to identify turns near support or resistance.
• Although the Stochastic indicator is a very simple tool and only looks at a few key data points on your charts, it can provide meaningful trend information.
• If you want to learn more about the relative strength index (RSI) and related trading systems, I recommend reading this article.

A bullish or positive divergence occurs when the market price moves to a new low, but the stochastic indicator increases. This is an indication of a possible upcoming trend reversal to the upside. He designed the indicator to calculate the location of the closing price of an asset compared to the low and high ranges of the same asset over a period of time. Essentially, the faster %K and slower %D lines are calculated to show the relationship between current and past prices.

Signals Summary

Readings below 20 occur when a security is trading at the low end of its high-low range. Lane also reveals that, as a rule, the momentum or speed of a stock’s price movements changes before the price changes direction. In this way, the stochastic oscillator can foreshadow reversals when the indicator reveals bullish or bearish divergences.

• The Stochastic RSI is an indicator that applies the formula of the stochastic oscillator to a set of Relative Strength Index (RSI) values, rather than a set of stock prices.
• As with other oscillators, the Stochastics displays the location of the closing price relative to the high and low range over a specific period of time.
• As a trading tool, the stochastic indicator is used to estimate when the price of an asset may be overbought or oversold.
• Should a security trade near support with an oversold Stochastic Oscillator, look for a break above 20 to signal an upturn and successful support test.
• The stochastic oscillator is a helpful tool for experienced and novice traders.
• If an indicator rises above 80, the instrument trades near the top of its high-low range and is currently overbought.
• For example, when the oscillator indicates bearish divergence, the price may still continue climbing higher for several trading sessions before turning to the downside.

You can see how the Stochastics RSI triggers more overbought and oversold levels compared to the traditional Stochastics indicator. Both oscillators work on a zero to 100 scale, but their signals also vary. The RSI would indicate the market is overbought if it reaches above 70, while stochastic indicator explained the stochastic oscillator would need to reach 80. And the RSI would consider the underlying asset undersold if the indicator was below 30, while the stochastic oscillator would need to fall to 20. Stochastic divergence or Stochastic reversal can be traded nicely with trendlines.

Where Can I Use Stochastics To Trade?

On the bearish side, only readings of 15 and below are interpreted as indicated oversold conditions. While the adjustment to 85/15 does eliminate the number of false signals, it may lead to traders missing lucrative opportunities. A bull trade setup happens when the stochastic indicator makes a higher high. Yet, the instrument’s price makes a lower high, signaling that momentum is growing and the price could move even higher. In this case, traders often look to buy after a brief price pullback in which the stochastic indicator has dropped below 50, continuing to move higher again. This signals that selling pressure has decreased, and a reversal upwards could be about to emerge.

• Profit is gained due to narrow stop-losses and plenty of trades, but most of them should be profitable.
• Well, this my friend is what we call divergence in stock trading.
• They are included in the classic technical analysis and remain popular among plenty of traders.
• It’s hard to tell, especially if you’re using stochastics alone.
• However, when the formula is used to calculate the StochRSI, it is directly applied to the RSI data (prices are not considered).
• When using the Super Stochastic DA indicator, it is crucial to consider the four types of calculations and select the most suitable one for your trading strategy and market conditions.