Stochastic Oscillator

Stochastic Oscillator Explanation

The Stochastic Oscillator is a momentum indicator that can be used to determine entry and exit timing based on the overbought or oversold condition of the underlying financial instrument. Originally by Dr. Developed by George Lane in the 1950s, the concept was to compare the current price to the price range over a period of time. The indicator has three inputs based on the following formulas:

calculation

Slow% K = 100 [Sum of (C - L14) for the deceleration period% K / Sum of (H14 - L14) for the deceleration period% K]

Slow% D = SMA of Slow% K

OR:

C = final diploma

L14 = Lowest low of the last 14 periods

H14 = higher for the same 14 periods

% K deceleration period = 3

Overbought vs oversold

One of the biggest problems and mistakes in trading is the misinterpretation of overbought and oversold. Now we will take a look at these phrases and see why there is no such thing as overbought or oversold. The stochastic indicator does not show oversold or overbought prices. Show momentum. Generally, traders would say that a stochastic above 80 means that the price is overbought, and when the stochastic is below 20, the price is considered oversold. And what the traders mean is that an oversold market has a high probability of falling and vice versa. This is wrong and very dangerous! As we saw earlier, a stochastic above 80 means that the trend is strong, not overbought, and is likely to reverse. A stochastic high means that the price can close near the top and continue to rise. A trend with the stochastic staying above 80 for a long time indicates that momentum is high and you should not prepare to sell the market. The following image shows the behavior of the stochastic in a long uptrend and a downtrend. In both cases, the Stochastic went "overbought" (above 80), "oversold" (below 20) and stayed there for a while as the trend continued. Again, the belief that stochastic indicates oversold / overbought is wrong and you will quickly run into trouble if you trade this way. A high stochastic value shows that the trend has strong momentum and is NOT overbought.

2. Deviation

Divergence occurs when the price of the security reaches a new high or low that is not reflected in the stochastic oscillator. For example, the price reaches a new high, but the oscillator does not move to a new high as a result. This is an example of a bearish divergence that may indicate an impending market reversal from an uptrend to a downtrend. The fact that the oscillator did not reach a new high during price action suggests that the momentum of the uptrend is weakening. Also, a bullish divergence occurs when the market price reaches a new low, but the oscillator does not follow it and moves to a new low. A bullish divergence indicates a possible bullish reversal in the market. It is important to note that the stochastic oscillator can give a divergence signal at some point before the price movement changes direction. For example, if the oscillator gives a bearish divergence signal, the price may continue to rise for several trading sessions before falling. For this reason, Lane recommends waiting for confirmation of a market reversal before initiating a trade. Transactions should not be based solely on divergences.

3. Crosses

The crosses refer to the point of intersection of the fast stochastic line and the slow stochastic line. The fast stochastic line is the 0% K line and the slow stochastic line is the% D line. If the% K line crosses and crosses the% D line, this is a bullish scenario. In contrast, the% K line, which crosses the% D stochastic line from top to bottom, gives a bearish sell signal. Limitations of the Stochastic Oscillator The main disadvantage of the oscillator is its tendency to generate false signals. They are especially common in turbulent and highly volatile business conditions. For this reason, it highlights the importance of confirming the Stochastic Oscillator trading signals with indices of other technical indicators. Traders should always keep in mind that the oscillator is primarily designed to measure the strength or weakness, and not the trend or direction, of price movement in a market. Some traders aim to reduce the stochastic oscillator's tendency to generate false trading signals by using more extreme oscillator readings to indicate overbought / oversold conditions in a market. Instead of using values greater than 80 as a dividing line, they only interpret values greater than 85 as an indication of overbought conditions. On the bearish side, only values of 15 or less are interpreted as a sign of oversold conditions.

conclusion

While momentum oscillators are best for trading forks, they can also be used with stocks that follow a trend as long as the trend is in a zigzag format. Pullbacks are one of the bull trends zigzagging upward. Rebounds are one of the downtrends zigzagging downward. In this regard, the stochastic oscillator can be used to identify opportunities in line with the broader trend. The indicator can also be used to identify turns near support or resistance. If a security is trading near support with an oversold stochastic oscillator, look for a breakout above 20 to indicate a bounce and a successful support test. If security with an overbought Stochastic Oscillator is trading near resistance, look for a breakout below 80 to indicate a pullback and resistance failure. The stochastic oscillator setting depends on personal preference, trading style, and time period. A shorter lookback period creates a shaky oscillator with many overbought and oversold readings. A longer look-back period provides a smoother oscillator with fewer overbought and oversold values. As with all technical indicators, it is important to use the Stochastic Oscillator in conjunction with other technical analysis tools. Volume, support / resistance, and breakouts can be used to confirm or reject the signals generated by the  stochastic oscillator read more.

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