What it is and how to use it
What is it?
The Stochastic Oscillator is a momentum indicator that compares a security’s closing price to its price range over a given period. The indicator ranges from 0 to 100 and is used to identify overbought and oversold conditions. The Stochastic Oscillator is composed of two lines: %K and %D. %K is the main line, and %D is a simple moving average of %K.
Who made it?
The Stochastic Oscillator was developed by George C. Lane in the late 1950s. Lane was a technical analyst and one of the first researchers to use technical analysis as a forecasting tool.
How is it calculated?
%K = (Current Close - Lowest Low) / (Highest High - Lowest Low) * 100
%D = Simple Moving Average of %K over X periods (usually 3)
Where:
Lowest Low = Lowest low over the lookback period
Highest High = Highest high over the lookback period
Code (ProRealTime)
How do you use it?
You can use the Stochastic Oscillator in several ways to identify overbought and oversold conditions, gauge momentum, and spot potential reversal points.
Overbought/Oversold Conditions:
Overbought: When the Stochastic Oscillator rises above 80, it typically indicates that the asset is overbought and may be due for a pullback.
Oversold: When the Stochastic Oscillator falls below 20, it typically indicates that the asset is oversold and may be due for a rebound.
Momentum:
The Stochastic Oscillator can help gauge the momentum of price movements. Higher values during an uptrend indicate strong momentum, while lower values during a downtrend indicate weak momentum.
Trend:
The Stochastic Oscillator can also be used to identify trends. During strong uptrends, the oscillator often stays above 50 and frequently reaches 80 or higher. During downtrends, it tends to stay below 50 and frequently reaches 20 or lower.
Divergences:
Bullish Divergence: Occurs when the price makes a new low but the Stochastic Oscillator makes a higher low, indicating that selling momentum is weakening and a reversal may be imminent.
Bearish Divergence: Occurs when the price makes a new high but the Stochastic Oscillator makes a lower high, indicating that buying momentum is weakening and a reversal may be imminent.
Lookback Periods:
Shorter Periods (e.g., 5 periods): More sensitive to price changes and can generate more signals, useful for short-term trading.
Standard Period (14 periods): Provides a balance between sensitivity and reliability, suitable for swing trading.
Longer Periods (e.g., 21 periods): Less sensitive, generating fewer signals but providing more reliable long-term trend information.
FAQ
Q: What are the best settings for the Stochastic Oscillator?
A: The default settings for the Stochastic Oscillator are 14, 3, and 3, representing the %K period, the %D (smoothing) period, and the slowing period. Tweak these settings to find what works best for you.
Q: Is the Stochastic Oscillator good for swing trading?
A: Definitely! The Stochastic Oscillator is great for swing trading. It helps you find overbought and oversold conditions, signaling potential market reversals.
Q: Can the Stochastic Oscillator be used alone to make trading decisions?
A: While the Stochastic Oscillator gives solid signals, it's usually better to use it with other indicators to confirm trends and avoid false signals.
Strategies using the Stochastic indicator
None so far.