It helps in making informed decisions based on the market’s momentum and the strength of prevailing trends. The overbought line represents price levels that fit into the top 80% of the recent price range (high – low) over a defined period – with the default period often being ‘14’. Likewise, the oversold line represents price levels that fit into the bottom 20% of the recent price range. Crossovers refer to the point at which the fast stochastic line and the slow stochastic line intersect. The fast stochastic line is the 0%K line, and the slow stochastic line is the %D line. When the %K line intersects the %D line and goes above it, this is a bullish scenario.
When the stochastic line falls below 20 or rises above 80, it produces a trading signal. Rather than measuring price or volume, the stochastic oscillator compares the most recent closing price to the high-low range of the price across a fixed amount of past periods. The indicator’s goal is to predict price reversal points by comparing the closing price to previous price movements. The Stochastic Oscillator is a popular technical analysis indicator that calculates recent price data to determine average price levels. While there is no secret formula or all-in-one indicator, the stochastic oscillator is a favorite when used within its own realm. There are many technical indicators and trading tools that provide similar services, but the stochastic oscillator is a useful tool that can complement a trader’s overall trading strategy.
There are three versions of the Stochastic Oscillator available on SharpCharts. The Fast Stochastic Oscillator is based on George Lane’s https://www.bigshotrading.info/ original formulas for %K and %D. In fact, Lane used %D to generate buy or sell signals based on bullish and bearish divergences.
If they are moving in the oversold zone (a level below 20), he should consider buying. Next, let us take a look at two stochastic oscillator indicator charts. We will highlight some of the turning points which could have proved beneficial for traders. The first chart is the traditional (fast) stochastic oscillator indicator with a smoother %D trend line based upon the %K factor. Divergence-based trading is another strategy that makes use of the stochastic oscillator. As already discussed, a divergence between the price and the oscillator can signal a potential trend reversal.
While often used in tandem, they each have different underlying theories and methods. The stochastic oscillator is predicated on the assumption that closing prices should move in the same direction as the current trend. After recording the necessary price changes and their tendencies stochastic oscillator definition during the relevant period, the technician draws the lines on the chart. There is one line on the graph that represents the actual value of the stochastic oscillator for each period. There is another line that reflects the three-period (day) simple moving average.
The underlying security forms a lower high, but the Stochastic Oscillator forms a higher high. Even though the stock could not exceed its prior high, the higher high in the Stochastic Oscillator shows strengthening upside momentum. When the asset is oversold, the stochastic is below 20, while the RSI is below 30. When the asset is overbought, the stochastic is above 80, while the RSI is above 70. When choosing between Fast Stochastic and Slow Stochastic, it is better to start with the slow one, as it gives fewer signals. Its major disadvantage is that the signals will arrive with some delay compared to the fast stochastic.
Then we have the %D factor based upon the %K and gives an even smoother line. The longer you extend the period over which you examine the prices, including highs, lows, and current prices, the smoother the chart. On the upside, in many ways, this can help to offset short-term peaks and bottoms that can sometimes tempt people into buying and selling when they should not. There is a general consensus that when stochastic oscillator levels fall below 20, it indicates the asset is oversold.
In doing so, one should observe how the price and the D line move and monitor their changes. In other words, whether they move into overbought or oversold zones. If they are moving in the overbought zone (above 80), the trader should consider selling.
In addition, some traders use the stochastic as a filter to enter a position. They will not buy a security if they see the divergence of the lines of the oscillator itself (meaning the situation when %D and %K diverge from each other). Divergence is when the price goes in one direction, and the Stochastic goes in another. It signals that the price movement will change dramatically very soon.