Stochastic oscillator




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Stochastic oscillatorStochastic Oscillator

The Stochastic Oscillator was developed by Dr. George Lane to track market momentum.

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The indicator consists of two lines:

%K compares the latest closing price to the recent trading range.

%D is a signal line calculated by smoothing %K.

Slow Stochastic incorporates further smoothing and is often used to provide a more reliable signal.

Stochastic Oscillator Trading Signals

If the Stochastic Oscillator hovers near 100 it signals accumulation. Stochastic lurking near zero indicates distribution .

The shape of a Stochastic bottom gives some indication of the ensuing rally. A narrow bottom that is not very deep indicates that bears are weak and that the following rally should be strong. A broad, deep bottom signals that bears are strong and that the rally should be weak.

The same applies to Stochastic tops. Narrow tops indicate that the bulls are weak and that the correction is likely to be severe. High, wide tops indicate that bulls are strong and the correction is likely to be weak.

Ranging Markets

Signals are listed in order of their importance:

Go long on bullish divergence (on %D) where the first trough is below the Oversold level .

Go long when %K or %D falls below the Oversold level and rises back above it.

Go long when %K crosses to above %D.

Short signals:

Go short on bearish divergence (on %D) where the first peak is above the Overbought level .

Go short when %K or %D rises above the Overbought level then falls back below it.

Go short when %K crosses to below %D.

Place stop-losses below the most recent minor Low when going long (or above the most recent minor High when going short).

%K and %D lines pointed in the same direction are used to confirm the direction of the short-term trend.

Lane also used Classic Divergences. a type of triple divergence.

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Trending Markets

Only take signals in the direction of the trend and never go long when the Stochastic Oscillator is overbought, nor short when oversold.

If Stochastic Oscillator rises above the Overbought line, place a trailing sell-stop. When you are stopped in, place a stop loss above the High of the recent up-trend (the highest High since the signal day).

Stochastic Example

The Slow Stochastic Example illustrates the trading signals. This study focuses on the trailing stop entry technique used in a trending market.

Intel Corporation is shown with aВ 21 day exponential moving average (MA) and 7 day StochasticВ %K andВ %D. The MA is used as the trend indicator with closing price as a filter .

Stochastic Oscillator

The Stochastic Oscillator is a momentum indicator that compares a currency pairs closing price to the normal price range it has been displaying over a specified time period. The Stochastic Oscillator can has its sensitivity to market movements reduced or increased by adjusting the time period, or by taking a moving average of the result.

The idea behind the Stochastic Oscillator is that in an uptrend market, prices generally tend to close nearer to the high for the period, and during a downtrend market, prices will often tend to close near their low for the period. The indicator is often used in several different ways at one time as it is multi-faceted.

The first way traders will use this indicator is to trade like a moving average crossover system. In other words, when the quicker of the two moving averages crosses above the slower one, it is a buy signal. Of course, this works in the opposite direction as well. This shows the near-term momentum is building in one direction or the other.

Much like other oscillators, traders will often use the moving averages to determine whether there is likelihood of the currency pair being overbought or oversold as well. There are two lines, the 20 and the 80 that determine this. For example, if you are in a long position and see the Stochastics have the moving averages above the 80 line, you might be getting warned that the pair is now entering overbought territory. The same can be said for the averages dipping below the 20, as it signals oversold conditions.

The Stochastic Oscillator can also determine divergence as well. Generally speaking, when a pair is making new highs, you want to see the averages on the oscillator doing the same thing. If not, you have divergence and a possibly weak undercurrent to the recent surge upward. This works in reverse as well, as a failure to make new lows suggests that there isnt as much selling conviction in the marketplace as the new lows have been made.