The stochastic oscillator is a valuable indicator for overbought and oversold conditions. Typically, readings above 80 indicate that the instrument is in the overbought range, and readings under 20 suggest oversold conditions. Furthermore, oversold and overbought levels can be used to forecast trend reversals. Lane also reveals that, as a rule, the momentum or speed of a stock’s price movements changes before the price changes direction. In this way, the stochastic oscillator can foreshadow reversals when the indicator reveals bullish or bearish divergences. This signal is the first, and arguably the most important, trading signal Lane identified.

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. It’s your job to decide whether the oscillator’s signals match the supply and demand conditions in the real market. Before looking at some chart examples, it is important to note that overbought readings are not necessarily bearish. Securities can become overbought and remain overbought during a strong uptrend. Closing levels that are consistently near the top of the range indicate sustained buying pressure.

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A subsequent move below 80 is needed to signal some sort of reversal or failure at resistance (red dotted lines). Conversely, the oscillator is both oversold and weak when below 20. A move above 20 is needed to show an actual upturn and successful support test (green dotted lines). The https://www.bigshotrading.info/blog/what-is-the-stochastic-oscillator-and-how-to-use-it/ could be used by traders to identify momentum in price movements and determine potential entry and exit points. It measures the momentum and velocity of price movements by comparing a closing price to its recent price range over a given period.

You can find divergence using either of the indicators. Now, you’ll learn how to read this indicator’s signals. I bought your book (price action trading) wonderful book, l learned a lot of things and l m still learning by following your you tube channel. I like to code it in MT4, can explain how to enter the market and determine stoploss and take profit? During oversold or overbought, go back to SnR rules and candle anatomy to see it is reversal pin bar or engulfing candle or insider bar. Was following wrong path of buy or sell when overbought/oversold.

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Adding objective tools to your trading can often make a big difference. For example, if a stock with an overbought reading reverses, might that reversal indicate a small “dip,” a larger correction, or a longer-term downtrend? It’s hard to tell, especially if you’re using stochastics alone. How you respond to an asset that enters the oscillator’s overbought or oversold territories depends wholly on your outlook (short-term or long-term) and your strategy. The Stochastic oscillator is another technical indicator that helps traders determine where a trend might be ending.

Most of the time, the Stochastic indicator follows the price movement, but when it does not, we call this a Divergence which indicates a weakness in the current trend. Stochastic gives a buy signal when there is a positive crossover between the k% line and D% line and sell signals when there is a negative https://www.bigshotrading.info/ crossover between the k% line and D% line. Traders need to always keep in mind that the oscillator is primarily designed to measure the strength or weakness – not the trend or direction – of price action movement in a market. However, the indicator works differently depending on the settings you choose.

What’s the rationale behind the stochastic oscillator?

An instrument’s price can continue to rise or fall for a long time, even while divergence is occurring. For example, when the oscillator indicates bearish divergence, the price may still continue climbing higher for several trading sessions before turning to the downside. The price is moving lower if the stochastic indicator falls from above 80 to below 50. The price is moving higher if the indicator shifts from below 20 to above 50. Although the Stochastic indicator is a very simple tool and only looks at a few key data points on your charts, it can provide meaningful trend information. The belief that the Stochastic shows oversold/overbought is wrong and you will quickly run into problems when you trade this way.

These two lines are shown on a scale of 1 to 100 with key trigger levels shown at 20 and 80. These lines are represented by a blue and an orange line. Any action outside these lines is considered to be particularly significant. You just check the total distance of the range between the highest high and the lowest low. And then all you do is see how close the price is closing to the highest high or the lowest low.

Stochastic Divergence

Still, it’s worth thinking about your strategy, as it’s always better to pick up the conditions that will work for you. Both technical tools are oscillators used to gauge market momentum. When it’s inside these areas, the indicator doesn’t guarantee a 100% reversal. If the market trend is robust, there are risks the price won’t reverse.