Stochastic Oscillator: How to Apply this Indicator in Trading?

waves of stochastic oscillator

You know, there is a great number of technical indicators on Forex. All of them are intended to help a trader gain more profit. Today I want to talk about one of the most often applied indicators Stochastic Oscillator. Let’s consider how does it work.

What is this Stochastic?

Stochastic Oscillator or simply Stochastic is an indicator that shows the ratio of the current closing price to its price range for a certain period of time in the past.

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To construct the Stochastic indicator, 2 lines are used – the fast one, which is called %K, and the slow one – %D, as well as 2 levels – 20% and 80%. If Stochastic is located in the range of 80-100%, it indicates that the market is overbought and gives a signal to sell. Respectively, the location between 0 and 20% is about the oversold market and gives a signal to buy. Some traders use non-standard values of 30 and 70%, which increases the accuracy of entering the market.

Properties of Stochastic

Stochastic Oscillator

%K period shows the Oscillator period. It is the main line of the oscillator.

%D period shows the Oscillator signal line period. This period is, in fact, a moving average of %K line.

%K curve appears on the graphs in form of a continuous line, and slower %D curve is dashed.

Slowing is an additional smoothing of %K and %D lines.

Prices field allow to choose the prices for the Oscillator calculation – according to the prices lows/highs or according to the closing prices.

MA method is the method for calculating %D line.

Stochastic Oscillator main signals

The main types of the Stochastic Oscillator signals are:

  1. divergences;
  2. %K and %D curves crossing;
  3. %K and %D curves direction.

Bull and bear divergences

The best signal of Stochastic Oscillator is the divergence of %D line or %K line with the price. Simply put, the stochastic and the price move in opposite directions.

The bullish divergence is formed when, in a downtrend, there are descending peaks on the price chart and rising peaks on the stochastic chart. It’s a buy signal.

what is Stochastic Oscillator

The bearish divergence occurs when, in an uptrend, there are sequentially rising peaks on the price chart and descending peaks on the stochastic chart. It’s a sell signal.

How to use Stochastic Oscillatore

%K and %D curves crossing

Some signals are formed when %K and %D intersect. The signals come in the following way:

    • buy when %K crosses %D from bottom to top;

 

    • sell when %K intersects %D from top to bottom.

 

Stochastic Oscillator

Such a system is similar to the moving average crossing system (since %D is the moving average of %K).

%K and %D curves direction

Open buy position when Stochastic Oscillator (%K or %D) first drops below a certain level (usually 20) and then rises above it.

Open sell position when Stochastic Oscillator (%K or %D) first rises above a certain level (usually 80) and then drops below it.

how to use Stochastic Oscillator

Do not open positions only according to the signals of Stochastic. This indicator can become an excellent addition to your trading system. Combine Stochastic with other indicators (preferably the trend ones) and analysis methods. It is ideal to use the Stochastic Oscillator during the flat. Hope my notes will help you in making technical analysis.

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