Stochastic indicator is a tool that identifies overbought and oversold areas, providing potential reversal signals. It is surprising how many traders do not understand what it means. Crypto Trading will accompany you to explore the Stochastic indicator RSI indicator and how to apply it in your trading and investment strategies.
Introduction to the definition of Stochastic indicator
Learn about the concept, formula, and structure of the Stochastic indicator through the sections below:
What is the definition of a Stochastic indicator?
The Stochastic Oscillator was invented by Dr. George C. Lane in the late 1950s. It is a momentum measurement tool. It compares the closing price to the price range of an asset over a specific period. Stochastic has many applications. These include divergence, day trading, scalping, Buy/Sell confirmation, and overbought/oversold confirmation. One of its major advantages is its ability to measure the momentum of a market, providing a signal of movement before it occurs.
One concept that is easily confused with the Stochastic indicator is the CCI indicator. They are both widely used technical analysis tools in Forex. As mentioned above, Stochastic is calculated based on the ratio of the closing price to the price range. While CCI is calculated based on the average price deviation from the average value. Therefore, it is important to distinguish between the two concepts and understand What is CCI indicator to make more effective trading decisions.
What is the Stochastic formula?
Usually, when wanting to know the What is stochastic index, investors can use the following formula:
Here:
C is the current closing price
L14 is the lowest price in the last 14 sessions
H14 is the highest price in the last 14 sessions
%K represents the ratio between the market price and the lowest price over the last 14 sessions.
%D is the 3-period moving average (SMA) of %K, also known as the slow Stochastic wave. Because it reacts more slowly to market price changes than %K.
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Detailed structure of Stochastic Oscillator
The Stochastic indicator compares the closing price position with the price range and is represented by two lines: %K and %D.
- %K line (blue) is the main line, close to the price range under consideration.
- %The %D line (orange) is the moving average. It is calculated based on the SMA3 of %K, with a lag compared to %K.
- The default values for the borders are 20 (bottom border) and 80 (top border).
Above the 80 lines, the market is overbought. Below 20, the market is oversold. %K generally reflects price action, and %D is an average based on %K. Traders use fast %K signals and slow %D divergence to identify overbought, oversold areas, and reversal signals.
How to use Stochastic indicator effectively
Stochastic indicator plays an important role in financial investment. However, to correctly determine the market trend, it is necessary to combine it with other indicators as follows:
Using Stochastic with Reversal Candlestick Patterns
This trading method is a useful addition to the strategy. When detecting divergence between Stochastic and price along with a strong reversal candlestick pattern. This makes the reversal signal more reliable.
Buy Signal: In a downtrend, if Stochastic and price have bullish divergence and bullish candlestick patterns appear such as Hammer candle, Dragonfly Doji, Inverted Hammer, Bullish Engulfing…
Sell Signal: In an uptrend, if a bearish divergence is detected between Stochastic and the price and confirmed by a bearish candlestick pattern such as Hanging man, Gravestone Doji, Bearish Engulfing, Shooting star…, then it is the right time to sell.
Combining Stochastic indicator Oscillator with Moving Average
This is one of the simplest strategies to identify trends, providing reliable signals to investors. To identify long-term trends, we use the daily time frame and monitor the MA200 line.
In the case of a long-term uptrend, the price usually stays above the MA200 line, treating it as a dynamic support level. Conversely, in a long-term downtrend, the price usually stays below the MA200 line.
Buy signal: When the price crosses the MA200 line and the Stochastic indicator enters the oversold zone.
Sell signal: When the price is below the MA200 line and the Stochastic indicator enters the overbought zone.
Sử dụng Stochastic indicator RSI
Stochastic indicator RSI is usually represented from 0 to 1 (or 0 to 100 on different charts). Combining the Stochastic indicator RSI formula is an important tool in technical analysis. Investors often use the Stochastic indicator RSI to determine overbought and oversold zones. To increase the ability to accurately assess. To determine market trends, it is necessary to combine support and resistance zones on larger time frames. Prioritize trading according to market trends: buy when prices increase and sell when prices decrease.
Buy signal: When Stoch and RSI move up from the oversold zone, bullish momentum is likely to occur.
Sell signal: When both Stoch and RSI indicators go down from the overbought zone, it predicts a possible bearish correction.
Entry point: Place a buy order at the signal zone on the green candle, and place a sell order at the signal zone on the red candle.
Stop loss: Use the ATR indicator or place stop loss below the support zone for buy orders and above the resistance zone for sell orders.
Stochastic indicator oscillator combined with Trendline
Combining the Stochastic Oscillator with trendlines is a method to increase accuracy in market forecasting.
Buy Signal: In the Uptrend market, draw an uptrend line and wait for the price to touch that trendline after correction, and at the same time, Stochastic Oscillator is in an oversold zone.
Sell Signal: In a Downtrend market, draw a bearish trendline and wait for the price to touch the trendline after an upward correction, while the Stochastic Oscillator is in the overbought zone.
How to trade
Entry point: For Buy orders, investors can open orders when the price touches the uptrend line. For Sell orders, open orders when the price touches the downtrend line.
Stop Loss: Place stop loss below the trendline for Buy orders and above the trendline for Sell orders.
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Stochastic Meaning
Stochastic indicator has many applications:
- Identify overbought/oversold status (Above 80 – overbought market / Below 20 – oversold market):
Above 80: Overbought market, sell only when %K cuts %D from above to 80, sell signal.
Below 20: Market is oversold, only buy when %K cuts %D from below to the 20 area, buy signal.
- Identify buy/sell signals (%K and %D cross down from above 80 – sell / %K and %D cross up from below 20 – buy):
Stochastic crosses down from above 80: Sell signal.
Stochastic crosses up from below 20: Buy signal.
- Detecting Bullish Divergence and Bearish Divergence:
Bullish Divergence: Lower low on price chart, but higher high on Stochastic.
Bearish Divergence: Higher highs on the price chart, but lower lows on the Stochastic.
A stochastic Oscillator is suitable when the market has no clear trend. The 20-80 zone can change depending on the market. For short-term trading, 5-3-3 can be used, while 5-5-5 is suitable for long-term trading.
What to note when using a Stochastic indicator?
Here are some important things to keep in mind when using the Stochastic indicator in trading:
- Stochastic signals are usually more reliable on larger time frames. However, they are susceptible to noise on smaller time frames due to the appearance of many false signals and trend structure breakdown.
- Although Stochastic can predict short-term price trends, other tools should be used to confirm the information. To avoid risky judgments leading to losses.
- Stochastic is a momentum indicator, which shows the expected direction of price movement in the future. This can be an important reference for price trend forecasting.
- Be careful when making reversal trades on small time frames, especially for new traders. Because they can be risky and difficult to identify signals.
- Do not rely solely on Stochastic to make trading decisions. To enhance the performance of the signal, it is necessary to combine it with other tools. Using the Stochastic indicator alone can lead to risky trades.
Conclude
The stochastic indicator is often used to identify overbought and oversold levels as well as divergence in the market. Using Stochastic effectively requires flexibility, updating, and choosing the right time frame. And also combining with other analytical tools to make accurate decisions. Refer to Crypto Trading articles to better understand these tools.
FAQs
Stochastic indicator how to determine market trend?
Stochastic is not an exact tool to determine market trends. However, it can assist traders. By determining market entry and exit points based on price distribution.
What other tools should I combine the Stochastic indicator with to increase trading efficiency?
To increase trading efficiency, you can combine Stochastic with other tools to determine market entry and exit points more accurately.
How to learn more about using Stochastic indicator?
You can learn more about how to use Stochastic by reading technical analysis books, or by participating in online courses and forums about stock trading.
