What is a Stochastic Oscillator? Indicator formula and trading strategies

On the chart above where the lowest prices are, I marked the entry level with a green line. Below I will show how to use the https://www.bigshotrading.info/ by spotting the overbought and oversold conditions on the EURUSD chart. If the stochastic indicator breaks the signal line bottom-up (green arrow), open a long position.

It is not a solicitation or a recommendation to trade derivatives contracts or securities and should not be construed or interpreted as financial advice. Any examples given are provided for illustrative purposes only and no representation is being made that any person will, or is likely to, achieve profits or losses similar to those examples. DailyFX Limited is not responsible for any trading decisions taken by persons not intended to view this material. As any veteran trader will tell you, acting on false signals means buying and selling too soon and hitting stop-loss orders before a profit target is achieved. If the trader’s objective is to “buy low, sell high,” trading on false signals often leads to the opposite scenario.

How to use the stochastic oscillator

A divergence between the most recent closing price and curves’ direction is also a reversal signal. Bullish and bearish patterns appear rarely, but they are highly accurate signals. They precede the short-term price bottom, followed by the trend reversal. In technical analysis of securities trading, the Stochastic Oscillator is a momentum indicator that uses support and resistance levels. The relative strength index (RSI) and stochastic oscillator are both price momentum indicators that are widely used in technical analysis. Although they are regularly used together, they are different tools.

Generally, a sell position should be open when the line breaks the 80% level back from the top, where the last closing price is, and follows the downward direction. Nevertheless, it’s not recommended to trade using only the stochastic oscillator as a momentum indicator. In the simplest stochastic oscillator strategy, signals are filtered by the trend direction. Combining a stochastic indicator with other trading tools can help the user to spot easier overbought and oversold conditions. To sum up, as one of the most popular widely-used technical indicators on the market, the stochastic indicator is mainly used to identify overbought and oversold levels.

Pros & Cons of the Stochastic Indicator

We calculate the slow indicator, as well as the average indicator from the primary indicator. The latter is also sometimes referred to as the fast stochastic indicator. This creates an even smoother chart where movements above 80 and below 20 can be rare. Ignore the fact that there is a different indicator in the article. The stochastic oscillator follows the classic rules of the technical analysis for bullish and bearish divergence and convergence.

• The take profit is placed at a distance of the stop-loss or more in 5-10 points.
• However, an overreliance on these signals, without a deeper understanding of stochastic oscillators, is likely to end in frustration.
• Once, while observing the price changes, he noticed that there was not a trend but a reciprocating movement that prevailed on the market.
• The stochastic momentum index (SMI) is based on the stochastic oscillator, and both tools are used to determine momentum in the market.
• It broke out above a 2-month trendline and pulled back (2), triggering a bullish crossover at the midpoint of the panel.

The stochastic indicator can also help you identify bull and bear setups in anticipation of a future reversal. Since the stochastic oscillator is range-bound, it’s beneficial for generating overbought and oversold signals. Some traders aim to lessen the Stochastic Oscillator’s tendency to generate false trading signals by using more extreme readings of the oscillator to indicate overbought/oversold conditions in a market. Rather than using readings above 80 as the demarcation line, they instead only interpret readings above 85 as indicating overbought conditions.