Stochastic Oscillator for Technical Analysis: How to Use and Read

Stochastic Oscillator

The principle of how this calculator works is straightforward. It is like the Excel Bollinger Bands Table (the link to the explained instructions is here). The stochastic oscillator indicator was invented in 1950 by American stock analyst George Lane. The stochastic oscillator formula is considered effective when it is used on a 1-minute timeframe as well as on hourly, daily, or weekly timeframes. To use the stochastic oscillator, it is first important to understand exactly what the readings are showing you.

Stochastic Oscillator

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 Stochastic Oscillator the trend has strong momentum and NOT that it is ready to turn around. The image below shows the behavior of the Stochastic within a long uptrend and a downtrend.

How Do You Read the Stochastic Oscillator?

One way to curb false signals is to use more extreme oscillator readings to indicate overbought/oversold conditions in a market. For example, rather than using readings above 80 as the distinction line, they only interpret readings above 85 to signal overbought conditions. A bear trade setup ensues when the stochastic indicator makes a lower low. Yet, the instrument’s price makes a higher low, indicating that selling pressure is mounting as the security’s price may fall even more. As a result, traders often look to place a sell trade after a brief rebound in the price. A bull trade setup happens when the stochastic indicator makes a higher high.

What does stochastic indicate?

Stochastics are used to show when a stock has moved into an overbought or oversold position. it is beneficial to use stochastics in conjunction with other tools like the relative strength index (RSI) to confirm a signal.

If the stochastic indicator breaks the signal line bottom-up (green arrow), open a long position. A stop-loss can be placed slightly below local minimums within several candles from the entry point. Close the position at either a take profit level, which is 2-3 times bigger than stop-loss, or when a reversal signal occurs in order to avoid losing money rapidly. Once, while observing the price changes, he noticed that there was not a trend but a reciprocating movement that prevailed on the market.

What does the stochastic indicator mean?

You can change these parameters in the “Style” tab of the indicator’s settings. When monitoring a trading range like the above, we can spot an alternative option to define the take profit level. When the market price falls, relocate the stop-loss to a breakeven zone. Touching or crossing the 20% level will be a signal to close a position. 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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