Stochastic Oscillator Formula


When it comes to generating, the Stochastic Oscillator can indeed produce quality signals. Keep in mind though, that when using it as a signal generator (especially for divergences and bull/bear setups) it is best when used going with the trend. The technical analyst should be aware of the overall trend of the market. It would not be unwise to use Stochastic along with other means of technical analysis such as trend lines to confirm the market direction. Because of the oscillating nature of the stochastics indicator, it is possible to use stochastics to identify overbought and oversold levels in a similar way to how RSI is used.


  • This line is plotted alongside %K to act as a signal or trigger line.
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  • We close the trade when the stochastic indicator comes closer to the 90% line where we compare it with the most recent closing price.
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  • Intel Corporation is shown with a21 dayexponential moving average and 7 day Stochastic%K and%D. The MA is used as the trend indicator with closing price as a filter.

In low margin, calendar futures spreads, one might use Wilders parabolic as a trailing stop after a stochastics entry. A centerpiece of his teaching is the divergence and convergence of trendlines drawn on stochastics, as diverging/converging to trendlines drawn on price cycles. Dr. George Lane developed the Stochastic Oscillator in the late 1950s for use in technical analysis of securities. Lane, a financial analyst, was one of the first researchers to publish research papers on the use of stochastics.

He enjoys learning about the practical and theoretical side of investment, together with good old-fashioned gut instinct. Mark believes that keeping up with, and understanding the latest trends, is an important part of any investor’s arsenal – knowledge is everything. In other words, the way you use stochastic signals depends on your position holdings, your approach, your risk tolerance, and your trading/investing objectives. Length of moving average in periods for PercentD, specified as the comma-separated pair consisting of ‘NumPeriodsD’ and a scalar positive integer.


However, as you will see often, it is not a reliable indicator to use these crossovers. In most cases, a bullish signal emerges when the two lines of the oscillator make a crossover below the oversold level. The 37.5% in this example shows that today’s close was at the level of 37.5% relative to the security’s trading range over the last 10 days. If today’s close was 42, the Stochastic Oscillator would be 50%. This would mean that that the security closed today at 50%, or the mid-point, of its 10-day trading range.

A combination of the stochastic indicator %К and its moving average, named D , became the best option that can spot when the asset is overbought or oversold. 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. 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. The fast stochastic line is the 0%K line, and the slow stochastic line is the %D line.

The fading momentum will continue to push it higher at a drastically falling speed. However, when the positive momentum eventually ends, the rocket will turn and head back towards earth. Using the recent highs and lows for comparison, you should be able to identify a change in momentum. Ralph Dystant and George C. Lane were integral to creating the stochastic oscillator indicator and the influence it still holds with investors today. In many ways, the key to its success is its relative simplicity. The masterstroke was introducing an easy-to-understand range between zero and 100.

overbought and oversold

However, we can consider them strong signals when they do occur. As a trading tool, the stochastic indicator is used to estimate when the price of an asset may be overbought or oversold. By signaling these levels, the oscillator indicates when prices may be due for a reversal, which helps traders identify the best time and price to buy or sell an asset. When using the stochastic indicator on Forex trading, there are many signals, including the overbought and oversold levels of the market. That’s why this momentum indicator is often used with other indicators for more accurate signals.

How To Spot Stochastics Buy & Sell Signals

The recommended and most commonly used value is 3 when the oscillator is used together with some other indicators or 5 when it is used alone. A stochastic oscillator provides plenty of entry and exit signals indicating where the highest and lowest price is. The leading one among them is the cross of %K and %D lines from bottom to top above the 80% level and from top to bottom below the 20% level.

How to read the Stochastic indicator according to this function is the easiest. The indicator of George Lane’s creation has two extreme levels, 80 and 20. Each of these levels acts as an overbought and oversold limit.

If price volatility is high, an exponential moving average of the %D indicator may be taken, which tends to smooth out rapid fluctuations in price. Martin Pring’s Technical Analysis Explained explains the basics of momentum indicators by covering divergences, crossovers, and other signals. There are two more chapters covering specific momentum indicators, each containing a number of examples. The average true range is a market volatility indicator used in technical analysis. Stochastic oscillators measure the momentum of an asset’s price to determine trends and predict reversals. %K measures the current closing price against the range of prices within a certain period.

technical indicators

The Strength Index is a momentum indicator that measures the magnitude of recent price changes to analyze overbought or oversold conditions. Divergence here means the gap that occurs between the lines% K and% D. Because% K moves faster than% D, the gap that occurs indicates the strength of the trend direction movement.

Similarly, a bullish divergence occurs when both %K and %D fall below the oversold level of 20, and %D forms two successively higher bottoms while the price continues to decline. A reading of 0 means that the latest closing price is equal to the lowest price of the price range over the chosen time period. The %K determines where the price closed in relation to a range (i.e. period) of candlesticks. For example, a reading above 80 implies that the current closing price is near the highest high of the range, which is in fact the highest price of the last 5 candlesticks.

Volume Weighted Average Price (VWAP)

For more information, read the MVA and EMA articles and see calculation formulas later in this article. On the following picture, you can see examples of the STOCHASTIC oscillators with different %D slowing periods parameter’s values . Towards the start of this chart , you will notice that the purple line, the short-term %K line, moves up through the %D line around the 20% level.

simple moving average

The basic concept behind the stochastic oscillator is momentum. It gives you the ability to monitor the momentum of an asset’s price. Doing so lets you see whether it is potentially oversold or overbought compared to recent highs and lows.

How Does the Stochastic Oscillator work?

Similarly, if it the oversold level, it might be a time to sell. Rather than using readings above 80 as the demarcation line, they instead only interpret readings above 85 as indicating overbought conditions. On the bearish side, only readings of 15 and below are interpreted as signaling oversold conditions. Meanwhile, the RSI tracks overbought andoversoldlevels by measuring the velocity of price movements. The second thing to look for to confirm a potential bullish or bearish reversal is whether the %K line crosses above or below the %D line, respectively. Since the %D line lags the %K line, this indicates a shift in momentum similar to a signal line crossover on an MACD chart.

Traditionally, readings over 80 are considered in the overbought range, and readings under 20 are considered oversold. However, these are not always indicative of impending reversal; very strong trends can maintain overbought or oversold conditions for an extended period. Instead, traders should look to changes in the stochastic oscillator for clues about future trend shifts. The second example shows the effectiveness – and complexity – of using stochastics to identify and trade on overbought and oversold levels. The chart of Microsoft shows numerous periods during which the stochastics oscillator indicates that the stock is overbought given a %K above 80. At the end of many of these periods, a dip below 80 coincides with a bearish crossover of the %D line and immediately precedes a pullback that could be traded on.

Risks and Limitations of The Indicator

Overbought and oversold levels mean that the security’s price is near the top or bottom, respectively, of its trading range for the specified time period. However, as with RSI, the interval used for calculating stochastics may alter the interpretation of overbought and oversold levels. A move in %K back above 20 or below 80, combined with a %D crossover and information from additional indicators such as RSI and MACD, is necessary to identify a potential reversal. %D slowing periods – the parameter allows to specify the number of periods of the smoothing technique used in calculation of the %Kand %D lines.

The first step is to decide on the number of periods (%K Periods) to be included in the calculation. The norm is 5 days, but this should be based on the time frame that you are analyzing. Also, you should leave the upper overbought band intact at 80 and the lower band at 20.


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