What is Stochastic Oscillator?
A momentum indication that displays a security's price sensitivity to the time span over which the price sensitivity was measured is known as a stochastic oscillator indicator, or simply stochastic. By comparing a security's closing price on a given day with its price history, it displays levels of overbought and oversold conditions.
A momentum indicator known as a stochastic oscillator compares a security's closing price to a range of its prices over a given amount of time. You may lessen the oscillator's sensitivity to changes in the market by changing the time period or calculating a moving average of the outcome. It uses a 0–100 defined range of numbers to produce trading signals for overbought and oversold conditions.
KEY KNOWLEDGE
Understanding Stochastic Oscillator:
Values under 20 are often regarded as oversold, while values over 80 as being in the overbought zone. These do not, however, automatically portend an imminent reversal; strong trends have the ability to sustain overbought or oversold circumstances for a lengthy length of time. Traders could instead watch for variations in the stochastic oscillator as a signal about potential future adjustments in the trend.
Two lines typically make up a stochastic oscillator chart: one represents the oscillator's three-day simple moving average and the other its actual value for each session. The junction of these two lines is regarded as an indication that a reversal may be imminent since price is believed to follow momentum and shows a significant daily movement in momentum.
Formula for Stochastic Oscillator:
%K = (Current Close - Lowest Low)/(Highest High - Lowest Low) * 100
%D = 3-day SMA of %K
Lowest Low = lowest low for the look-back period
Highest High = highest high for the look-back period
%K is multiplied by 100 to move the decimal point two places
How to Aanlyse Stochastic Oscillator:
The stochastic indicator analyzes a price range over a specific time period or price candles; typical settings for the Stochastic 14 periods/price candles.
A HIGH STOCHASTIC NUMBER
The high is at 0.6283
The low is at 0.6258
And the close is at 0.628
The range between the high and the low is 0.0025 (0.6283 - 0.6258).
And the distance between the close and the highest high is 0.0003 (0.6283-0.628).
All we do now is divide 0.003 by 0.0025 to check how close is the price to the absolute high of that range. The calculation gives us 12%.
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.
A LOW STOCHASTIC NUMBER
OVERBOUGHT AS OVERSOLD
Generally, traders would say that a Stochastic over 80 suggests that the price is overbought and when the Stochastic is below 20, the price is considered oversold. And what traders then conclude is that an oversold market has a higher chance of going down and vice versa. This is wrong and very dangerous
As we have seen above, when the Stochastic is above 80 it means that the trend is strong and not that it is likely to reverse. A high Stochastic indicates that the price is able to close near the top and kept pushing higher. A trend in which the Stochastic stays above 80 for a long time signals that momentum is high and not that you should get ready to short the market.
The image below shows the behavior of the Stochastic within a long uptrend and a downtrend. In both cases, the Stochastic entered “overbought” (above 80), “oversold” (below 20) and stayed there for quite some time, while the trends kept on going.
The belief that the Stochastic shows oversold/overbought is wrong and you will quickly run into problems when you trade this way. A high Stochastic value shows that the trend has strong momentum and NOT that it is ready to turn around.
THE STOCHASTIC SIGNAL
Frequently Asked Questions
80 and 20 are the most common levels used, but can also be modified as required. For OB/OS signals, the Stochastic setting of 14,3,3 works well. The higher the time frame the better, but usually a H4 or a Daily chart is the optimum for day traders and swing traders.
Stochastic Oscillator 14 3 3 is used to: (1) Identify overbought and oversold levels. (2) find divergences and. (3) identify bull and bear set ups or crypto signals.
It is often used to indicate oversold (top of range) or overbought (bottom of range) conditions. The oscillator's basic calculation is 100*(current price-period low)/(period high-period low). This is a fully configurable version of the Slow Stochastic Oscillator.
Related to Technical Analysis:
