Stochastic Oscillator Explained

oversold readings

Dips below 20 warn of oversold conditions that could foreshadow a bounce. Moves above 80 warn of overbought conditions that could foreshadow a decline. Notice how the oscillator can move above 80 and remain above 80 . Similarly, the oscillator moved below 20 and sometimes remained below 20. The indicator is both overbought AND strong when above 80. A subsequent move below 80 is needed to signal some sort of reversal or failure at resistance .

stochastic oscillator explained

The time period to be used in additional smoothing of the %K. A Bear Setup occurs when price records a higher low, but Stochastic records a lower low. The setup then results in a bounce in price which can be seen as a Bearish entry point before price falls.


The of %K line defines the range that the indicator will use to compare the current price. The %D line period determines the smoothing of the %K curve to get the slow stochastic. When analyzing the market, traders consider both the cross of these lines and their movement to the overbought/oversold zones in order to spot the highest and the lowest price. A bullish pattern is adjusted when the new highest price forms a lower-than-previous high, but the stochastic has a higher high than the last closing price. It leads to a short-term price trend decline and a reversal. So, this pattern should be used as a bullish entry point ahead of the upcoming rise.

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We can open a buy trade after the cross and closure of the signal candlestick. When this phenomenon we say that a bullish divergence occurs. In addition to the classic stochastic indicator, a modified version called the Stochastic Momentum Index indicator, or SMI, is widely used.

It’s essential to determine the technical indicator’s direction and its location in the area above or below 50%. In our case, the blue main %K line is in the chart’s upper zone and is moving down . If you don’t want to use smoothing, you should use 1 as the last parameter. It’s a simple moving average built on the final parameters of %K. The principle of how this calculator works is straightforward.

  • And from the looks of it, it seems that Stochastic indicator can pinpoint the tops/bottoms of a range with deadly accuracy.
  • As there is a crossover of the indicator lines above 80%, a short-term correction should end, and the downtrend will continue pushing the oversold levels lower.
  • The Full Stochastic Oscillator moved below 20 in early September and early November.
  • He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.

Stochastics is mainly used as an oversold or overbought indicator. This works normally well in mean-reverting asset classes like stocks. Further below we provide examples of how you can utilize the indicator. Indicator description, settings, entry, and exit conditions.

Therefore, we will only open long while we monitor the most recent closing price. First, let’s look at how to add and set stochastic oscillator best settings for intraday timeframes. Based on the text above, you can recognize the bearish divergence from a bullish divergence, in the overbought or oversold region. If you aren’t sure yet, you should read the article”What the divergence on Forex is” where the issue is explained in detail.

Financial analysts use the stochastic indicator to get a sense of the current market sentiment. Graph readings nearing 0 indicate a bearish market, while those closer to 100 show a bullish sentiment. Many forex traders use the Stochastic in different ways, but the main purpose of the indicator is to show us where the market conditions could be possibly overbought or oversold. In a trend-following strategy, traders monitor the stochastic indicator to ensure it stays crossed in one direction. To calculate the stochastic oscillator, you subtract the low for the period from the up-to-date closing price.

Looking at this instrument’s historical price movements, it’s visible that the price decline doesn’t always follow a stochastic move to the overbought area. Vice versa, when the indicator is in the oversold zone, it’s more likely the market will rise soon. Big trading range periods for such a timeframe will be compensated by changing the limits to 30 and 70. You can change these parameters in the “Style” tab of the indicator’s settings. Still, results may vary on other timeframes and trading instruments. You can compare any type of stochastic indicator using a free demo account right now onLiteFinance in several clicks without registering.

Bull and bear set-ups

The red linesignalline is a 3-period moving average of %K, referred to as the slow stochastic%D line. The basic understanding is that Stochastic uses closing prices to determine momentum. When prices close in the lower half of the period’s high/low range, %K falls, indicating weakening momentum or buying/selling pressure. The Stochastics Oscillator is a range-bound oscillator consisting of two lines that move between 0 and 100. The first line (known as %K) displays the current close in relation to a user-defined period’s high/low range. The second line (known as %D) is a simple moving average of the %K line.

bollinger bands

This shows that there is less downward momentum and could indicate a bullish reversal. A stop-loss is a vital part of trading, as the stochastic may fail like any other technical analysis tool. The stochastic broke below 80 , so a trader would expect a further price decline. The price was falling for two days , but the decline wasn’t significant. Moreover, it was challenging to identify a take-profit level as the closest support level was too far .

How to read the stochastic oscillator?

Readings below 50 signal that the instrument is trading in the lower portion of the trading range. The difference between the slow and fast Stochastic Oscillator is the Slow %K incorporates a %K slowing period of 3 that controls the internal smoothing of %K. Setting the smoothing period to 1 is equivalent to plotting the Fast Stochastic Oscillator.

Typically, above 80 indicate that the instrument is in the overbought range, and readings under 20 suggest oversold conditions. Furthermore, oversold and overbought levels can be used to forecast trend reversals. 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.

If it is in the oversold area, you should open a long trade to avoid losing money rapidly. When two lines are above the upper level of 80% , the instrument is overbought. When they fall below the bottom horizontal line of 20% , it’s oversold. This is how the user can easily spot the overbought and oversold levels of the market. The Stochastic Oscillator Technical Indicator compares where a security’s price closed relative to its price range over a given time period.


Typically, the stochastic indicator is employed by experienced traders and those learning technical analysis. A stochastic oscillator is a momentum indicator comparing a particular closing price of a security to a range of its prices over a certain period of time. The sensitivity of the oscillator to market movements is reducible by adjusting that time period or by taking a moving average of the result. It is used to generate overbought and oversold trading signals, utilizing a 0–100 bounded range of values. The stochastic is often compared with relative strength indicator as both tools are oscillators that provide similar signals.

The settings on my Stochastic indicator is and it’ll show a single line instead of the traditional 2 lines. When the price forms lower highs but the stochastic has higher highs, the market is expected to turn down. When the price forms higher lows, but the stochastic has lower lows, the market is expected to turn up. When the price forms higher highs but the stochastic has lower highs, the market is expected to turn down. When the price forms a lower low, but the stochastic has higher lows, the market is expected to turn up.

Divergence between the stochastic oscillator and trending price action is also seen as an important reversal signal. Last Updated on November 19, 2022 Technical indicators offer powerful insights into what is happening in the market. While price is a factor in technical analysis, volume is as important as price as this tells traders the level of activity on a given security. The on-balance volume is one of the most popular volume indicators….

The stochastic indicator was based on the price bar’s major parameters – closing, high, and low prices. Day traders often use the stochastic indicator for intra-day trading. Technical analysts use it to gauge the momentum of a particular asset based on its price history. The 80 and 20 levels, together with a stochastic setting of 14, 3, and 3, are the most popular setting for intraday trading to provide overbought and oversold signals. This stochastic 50-level crossover is viewed as a strong movement to the upside and interpreted as a buy signal.

Combining a stochastic indicator with other trading tools can help the user to spot easier overbought and oversold conditions. In conclusion, the stochastic indicator is a useful technical analysis tool that can be used to identify overbought and oversold instruments. When combined with other indicators, the stochastic indicator can help a trader identify trend reversals, support and resistance levels, and potential entry and exit points. Price formations such as wedges and triangles and trendlines also work well with stochastic indicators. For example, the trader could monitor an established trend with a valid trend line and wait for the price to break the trend with confirmation from the stochastic indicator. To sum up, as one of the most popular widely-used technical indicators on the market, the stochastic indicator is mainly used to identify overbought and oversold levels.

A reading above 80 indicates that the instrument is trading near the top of its high-low range. A reading below 20 signals that the instrument is trading near the bottom of its high-low range. Stochastic oscillators tend to vary around some mean price level since they rely on an asset’s price history. It’s one of the most popular indicators, and it’s also quite useful. For a comparison, please see our ranking of the best oscillating trading indicators. A short-term lookback period of two to five days works best as long as the threshold is pretty low, like, for example, 25.

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