Stochastic Oscillator Overview, How to Calculate, and Uses

stochastic oscillator definition

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  • There are three versions of the Stochastic Oscillator available on SharpCharts.
  • The MACD or “Moving Average Convergence / Divergence” indicator is a momentum oscillator used to trade trends.
  • As a newbie from Nigeria I now know what and how to use stochastic oscillator.
  • Only a couple of short months later, the asset has reclaimed these moving averages and is ready to rally once again.
  • The signal line crosses and moves below 80 did not provide good early signals in this case because KSS kept moving higher.

The slow oscillator removes this by removing then emphasis because the %K in the slow stochastic oscillator is equal to the %D in the fast oscillator. The basic understanding is that Stochastic uses closing prices to determine momentum. When prices close in the upper half of the look-back period’s high/low range, then the Stochasitc Oscillator (%K) rises also indicating an increase in momentum or buying/selling pressure. When prices close in the lower half of the period’s high/low range, %K falls, indicating weakening momentum or buying/selling pressure. As mentioned above, divergences occur when the Stochastic Oscillator fails to establish a new price high or low. When the price makes a higher high while the Stochastic Oscillator makes a lower high, this is known as a bearish divergence. Before making an investment decision, you should rely on your own assessment of the person making the trading decisions and the terms of all the legal documentation.

Search overbought and oversold levels

As the stock closes nearer the high of the range, the Stochastic Oscillator rises, and as the stock closes nearer the low of the range, it falls. Divergence-convergence is an indication that the momentum in the market is waning and a reversal may be in the making. The chart below illustrates an example of where a divergence in stochastics, relative to price, forecasts a reversal in the price’s direction. The DeMarker indicator is a technical analysis tool that aims to measure the demand of an underlying asset and assess the directional bias of the market. How to read the Stochastic indicator according to this function is the easiest.

In that respect, we will now cover the Average True Indicator which helps us in making more informed trades and usually ups our confidence level. While RSI is used to detect the velocity of the market trend, the stochastic oscillator is built on the premise that the closing price should close in the same direction as the general trend.

The Formula for the Stochastic Oscillator Is

Typically, the Stochastic Oscillator is used for three things; Identifying overbought and oversold levels, spotting divergences and also identifying bull and bear set ups or signals. For example, comparing RSI with stochastic oscillator, it can be noticed that the stochastic oscillator works on the assumption stochastic oscillator definition that closing prices should reflect the current market trend. Meanwhile, the RSI measures the velocity of price changes to identify overbought and oversold levels. The RSI is generally more beneficial in growing markets, whereas stochastics are more helpful in sideways or turbulent markets.

What is an example of stochastic?

Stochastic processes are widely used as mathematical models of systems and phenomena that appear to vary in a random manner. Examples include the growth of a bacterial population, an electrical current fluctuating due to thermal noise, or the movement of a gas molecule.

In the example provided, price action can be seen trending downward with decreasing asset values. At the same time, the stochastic oscillator also continues to trend downward, heading deeper and deeper toward zero on the range graph. Stoch continuing to trend downward signals that the asset price will continue to follow until a trend reversal occurs. The Stochastic Oscillator is a popular, widely-used momentum indicator. Traders often use divergence signals from the oscillator to identify possible market reversal points.

Overbought/Oversold Conditions

Any values below 20 imply that the market is oversold, while anything above 80 suggests that it is overbought. Keep in mind that the indicator still shows overbought or oversold circumstances when it reaches values much above or below 80 and 20. The stochastic is just one of many technical indicators offered on the PrimeXBT trading platform. There, new traders can open a free demo account to get started with no risk at all, or sign up for a free trading account and get started profiting right away. You can see that in the graph above, in the first week of January 2019, %K crosses the %D line indicating the reversal of a trend. To support this trend, the ATR is also high during the same time period. We have reiterated before in this stochastic oscillator tutorial, that while an indicator is a good way to gauge the market, sometimes using a few indicators together is a good idea.

stochastic oscillator definition

Comparisons of these statistics are a good indicator of speed at which prices are changing or the Impulse of Price. %K is the same as Williams %R, though on a scale 0 to 100 instead of -100 to 0, but the terminology for the two are kept separate. The StochRSI is the second derivative of price, which means that it doesn’t always look similar to the price. Conversely, a reading above 0.80 suggests the RSI may be reaching extreme levels and could be used to signal a pullback in the underlying security. The stochastic oscillator displays the position of a stock’s closing price in respect to its high and low range over 14 days. According to Lane, the stochastic oscillator does not change in relation to price, volume, or other factors, rather Lane claims that the oscillator tracks the price’s pace or momentum. Traders often confuse any readings above 80 as overbought or readings below 20 as oversold, however, that’s not how the stoch functions.

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