What is the Stochastic Oscillator indicator?

The Stochastic Oscillator, like the RSI, is an effective tool for identifying overbought and oversold areas. And can provide potential reversal trading signals. However, many traders only use Stochastic without understanding its meaning. This article will help you understand the Stochastic indicator and how to apply it in trading. Let’s find out with Crypto Trading right away!

What is the concept of a Stochastic Oscillator?

The Stochastic Oscillator (Stochastic or Stock) is a momentum indicator that compares closing prices. Known as the price range of an asset over a certain period. Invented in the late 1950s by Dr. George C. Lane, the Stochastic indicator is one of the most popular tools used in Forex, index, and stock trading.

What is the structure of the Stochastic indicator?

Over a fixed period, the Stochastic indicator compares the closing price position with the price range. It is represented by two lines: the %K oscillator line (blue) and the %D moving average line (orange).

• The %K line is the main line and is close to the current price range. The %D line is a moving average calculated as an SMA3 of the %K line, lagging behind the %K line.
• The default boundaries are 20 (lower) and 80 (upper). Crossing the 80 line indicates an overbought market, and crossing the 20 line indicates an oversold market.
• The %K line typically reflects direct price action, while the %D is an average based on the %K. Traders often use signals from the %K and %D divergence to identify overbought, oversold areas, and reversal signals.

What does the Stochastic Oscillator indicator mean?

The Stochastic indicator has many applications:

• Determine overbought/oversold conditions (over 80 is overbought, under 20 is oversold). When Stochastic is above 80, the market is considered overbought. Only place a sell order when %K crosses %D from above to below 80. Conversely, when Stochastic is below 20, the market is considered oversold. Only place a buy order when %K crosses %D from below to above 20.
• Identify buy/sell signals (%K and %D cross down from above 80 – sell, %K and %D cross up from below 20 – buy).

See more: Capture indicator to strongly “buff” your transaction

How to install a Stochastic Oscillator simply

The Stochastic indicator is also available on trading platforms like MT4. Here’s how to install it on MT4:

1. Register and log in to your account on MT4.
2. On the toolbar, select “Insert” then “Indicators” next “Oscillator” and finally ” Stochastic Oscillator “.
3. Set the parameters in “Parameters”, “Scale”, “Levels”, and “Visualization”. In “Parameters”, set the period of %D, %K, and Slowing, and select the type of moving average in “Method”. The thickness and color of the lines can be adjusted.
   • Set the top and bottom borders in the “Levels” section.
   • Set the display time frame in “Visualization”.
4. Click OK to complete the Stochastic indicator settings on the price chart.

How to use the Stochastic indicator effectively

Although the Stochastic Oscillator is used to identify overbought and oversold areas for trading, using it alone can be difficult to get accurate signals. Experts recommend combining it with other tools such as RSI, OBV indicator, MA moving average, or price patterns to increase accuracy.

Stochastic Oscillator combined with RSI indicator

Stochastic RSI (StochRSI) indicator used in technical analysis, chart from 0 to 1 (or 0 to 100 on some platforms). Combine the Stochastic formula with the relative strength index (RSI) and other indicators such as the MFI indicator. Both belong to the group of momentum indicators, helping to identify overbought and oversold zones, increasing the probability of successful trading.

First, determine the trend (uptrend or downtrend) by combining support and resistance on higher time frames. Prioritize trading with the trend: buy when the trend is up, sell when the trend is down.

• Buy Signal: Wait for a pullback in an uptrend. When Stoch and RSI rise from oversold territory, a bullish signal.
• Sell ​​Signal: Both Stoch and RSI are falling from the overbought zone, the price is expected to end the increase in a downtrend.

Execute the indicator trading order as follows:

• Entry point: Place at the signal zone on the green candle for the Buy order and on the red candle for the Sell order.
• Stop Loss: Use the ATR indicator to calculate stop loss or place it near the support zone for the Buy order and near the resistance zone for the Sell order.
• Take Profit Point: Based on expected R: R ratio or important Fibonacci Extension levels.

Stochastic indicators can be combined with trendline

Combining the Stochastic Oscillator with trendlines is a way to increase your chances of success when trading.

• Buy Signal: If there is an uptrend and the price touches the uptrend line, and Stochastic is in the oversold zone.
• Sell ​​Signal: If the trend is down the price touches the downtrend line, and Stochastic is in the overbought zone.

Execute the combined indicator trade as follows:

Entry Point: For Buy, enter when the price touches the uptrend line, and vice versa for Sell.

• Stop loss: Place stop loss below the trendline for Buy and above the trendline for Sell.
• Take profit: Based on expected R: R ratio and important Fibonacci Extension levels.

See more: Instructions for opening an MEXC global account

Combining Stochastic indicator with reversal candlestick pattern

This trading method is an adaptation of the previous one. If Stochastic and price create divergence and strong reversal candlestick patterns appear, the reversal signal becomes more accurate.

• Buy Signal: In a downtrend, if there is a bullish divergence between Stochastic and the price. Along with reversal candlestick patterns such as Hammer, Dragonfly Doji, Inverted Hammer, Bullish Engulfing…
• Sell ​​Signal: If the market is rising, but there is a bearish divergence between Stochastic and the price. Accompanied by a reversal pattern such as Hanging Man, Gravestone Doji, Bearish Engulfing, Shooting Star… then you can place a sell order.

Some notes when using a Stochastic Oscillator

Here are some important notes for investors, helping them use the Stochastic indicator in trading effectively:

• Stochastic usually gives more accurate signals on higher time frames and is often noisy on lower time frames. This applies to most indicators. Because lower time frames often have many false signals and break the structure of the trend.
• Although Stochastic can identify short-term price trends, investors still need other tools to confirm information and avoid the risk of loss due to incorrect judgment.
• Stochastic is a momentum indicator that moves ahead of price action. This can help investors predict the potential direction of price movement.
• Be careful when trading reversals on lower time frames. Especially for new, inexperienced investors, as they may have difficulty identifying signals and executing orders.
• Do not rely solely on Stochastic and ignore other tools. Combining multiple indicators will increase the effectiveness of the signal and reduce the risk in trading. The risk will be high if you rely solely on Stochastic signals to make a trade.

Conclude

Above is the information about the Stochastic Oscillator that you may need. Although highly appreciated, Stochastic is just a trend prediction tool based on the highest and lowest prices in a trading cycle. Continue to follow Crypto Trading to learn more useful knowledge!

FAQs

How do you read the Stochastic Oscillator indicator?

The Stochastic Oscillator plots recent prices on a scale of 0 to 100. With 0 representing the lower limit of the recent period and 100 representing the upper limit. When the stochastic indicator has a value above 80, it indicates that the asset is trading near the top of its range. While a value below 20 typically indicates that the asset is near the bottom of its range.

What does %K represent on the Stochastic Oscillator?

On the Stochastic Oscillator, %K represents the current price of the asset. It is expressed as a percentage of the difference between its highest and lowest prices over a given period.

What does %D represent on the Stochastic Oscillator?

On the Stochastic Oscillator, %D represents the 3-period average of %K. This line is used to show the long-term trend of price and shows whether the current price trend will continue or not over the long term.