Stochastic Oscillator

◙ Primary Use: Evaluating the Trend and Detecting Overbought/Oversold Market Levels

◙ Trading: Identifying Trend Reversals/Continuation | Spotting Slope Divergences

◙ Standard Settings: 14 Periods (14,3,3)

Introduction to the Stochastic Oscillator

The Stochastic Oscillator is a popular momentum indicator used in technical analysis to gauge the speed and momentum of price movements. Developed by George Lane in the 1950s, it operates on the principle that in an uptrend, prices tend to close near their highs, while in a downtrend, they close near their lows.

The Stochastic is bounded between 0 and 100 and can identify overbought and oversold market levels as follows:

□ Overbought market levels at a reading above 80

□ Oversold market levels are at a reading below 20

 Calculating the Stochastic Oscillator

The Stochastic is formed by two lines

■ %K = {(Last Close - Lowest Low in K period)/(Highest High in K period - Lowest Low in K period)} * 100

Where,

K is the number of periods. Standard settings K=14 (14,3,3)

Trading with the Stochastic Oscillator

The Stochastic can be used for:

• Detecting overbought/oversold markets

• Identifying trend reversal/continuation

• Trading slope divergences

• Generating trade signals

Here is an example of Stochastic trade signals:

• A bullish trading signal occurs when the price forms a lower high but the Stochastic forms a higher high

• A bearish trading signal occurs when the price forms a higher low but the Stochastic forms a lower low

Advantages

(√) Works well in ranging markets (identifies reversals effectively).

(√) Simple to interpret (clear overbought/oversold levels).

Disadvantages

(x) Whipsaws in strong trends (can give false signals in trending markets).

(x) Best used with other indicators (e.g., MACD, moving averages).

Final Thoughts on Stochastic Oscillator

The Stochastic Oscillator is a versatile tool for traders to assess momentum, spot reversals, and confirm trends. While highly effective in sideways markets, it should be combined with other indicators for better accuracy in trending conditions. George Lane’s creation is helping traders make informed decisions based on price momentum.

 Platform Setup

You can install the Stochastic Oscillator directly in MetaTrader-4 or MetaTrader-5:

□ GO TO → INDICATORS → OSCILLATORS → STOCHASTIC OSCILLATOR

□ SETTINGS → 14 PERIODS

■ Stochastic Oscillator

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