stochastic oscillator definition

This helps us in another form, as the original stochastic oscillator was said to be very choppy and thus the slow stochastic oscillator serves to smoothen the movements. The %D becomes the 3-day SMA of the new slow stochastic oscillator. The indicator which we calculated is considered as the fast stochastic oscillator. The Slow Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods. The Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods.

  • The stochastic indicator helps traders identify trade exit and entry points by applying the overbought/oversold strategy.
  • While often used in tandem, there are notable differences between the two indicators.
  • The difference between the slow and fast Stochastic Oscillator is the Slow %K incorporates a %K slowing period of 3 that controls the internal smoothing of %K.
  • Before looking at some chart examples, it is important to note that overbought readings are not necessarily bearish.
  • Lastly, another widespread use of the stochastic indicator is identifying bull and bear trade setups.
  • Stoch continuing to trend downward signals that the asset price will continue to follow until a trend reversal occurs.
  • Now, as with most indicators, all of the periods used within Stochastic can be user defined.

As one of the easiest to read indicators, the stochastic oscillator works by measuring the relation between an asset’s price and its price range over a specific timeframe. 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.

Bull/Bear Divergences

In trading, the use of this term is meant to indicate that the current price of a security can be related to a range of possible outcomes, or relative to its price range over some time period. Moving average convergence/divergence is a momentum indicator that shows the relationship between two moving averages of a security’s price. Stock/Crypto traders commonly utilize the numbers 20 and 80 as key thresholds. Any values below 20 imply that the market is oversold, while anything above 80 suggests that it is overbought. Keep in mind that the indicator still shows overbought or oversold circumstances when it reaches values much above or below 80 and 20. The stochastic oscillator is an indicator that serves to indicate whether a cryptocurrency is being overbought or oversold.

stochastic oscillator definition

This signals that selling pressure is increasing and the instrument’s price could move lower. Traders often look to place a sell trade after a brief rebound in the price. When an increasing %K line crosses above the %D line in an oversold region, it is generating a buy signal. When a decreasing %K line crosses below the %D line in an overbought region, this is a sell signal.

How to use the stochastic oscillator

Dips below 20 warn of oversold conditions that could foreshadow a bounce. Moves above 80 warn of overbought conditions that could foreshadow a decline. Notice how the oscillator can move above 80 and remain above 80 . Similarly, the oscillator moved below 20 and sometimes stochastic oscillator definition remained below 20. A subsequent move below 80 is needed to signal some sort of reversal or failure at resistance . 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 .

stochastic oscillator definition

Conversely, the %K line crossing from above to below the %D stochastic line gives a bearish sell signal. A bullish scenario is when the %K line intersects the %D line and goes above it. This signals that upward momentum has slowed, and a reversal downward may take hold. The failure of the oscillator to gain a new high alongside the instrument’s price action doing so signals that the momentum of the uptrend is beginning to weaken. The stochastic oscillator and the relative strength index are both price momentum tools used to predict market trends.

Watching for Continuation By Gauging Trend Strength

The stock moved to higher highs in early and late April, but the Stochastic Oscillator peaked in late March and formed lower highs. The signal line crosses and moves below 80 did not provide good early signals in this case because KSS kept moving higher. The Stochastic Oscillator moved below 50 for the second signal and the stock broke support for the third signal.

  • This tells the trader the trend prior trend has ended, reversed, and is beginning to trend in the other direction.
  • Oversold conditions are when the Stochastic Oscillator crosses the lower threshold.
  • Keep in mind that the indicator still shows overbought or oversold circumstances when it reaches values much above or below 80 and 20.
  • The indicator shows how the current price compares to the highest and lowest price levels over a predetermined past period.
  • Only a couple of short months later, the asset has reclaimed these moving averages and is ready to rally once again.
  • That being said, the most common choices are a 14 period %K and a 3 period SMA for %D.

The Fast Stochastic Oscillator is based on George Lane’s original formulas for %K and %D. In this fast version of the oscillator, %K can appear rather choppy.

Example to understand Stochastic Oscillator

A white line, known as the %K line, will appear below the chart when the stochastic indicator is applied and reflects the actual value of the oscillator. And a red – referred to as %D – is the three-period moving average of %K. Since price is thought to follow momentum, the conjunction of these two lines can signal that a reversal may be on the way. The general theory serving as the foundation for this indicator is that in a market trending upward, prices will close near the high, and in a market trending downward, prices close near the low.

What is the meaning of stochastic oscillator?

A stochastic oscillator is a momentum indicator comparing a particular closing price of a security to a range of its prices over a certain period of time. The sensitivity of the oscillator to market movements is reducible by adjusting that time period or by taking a moving average of the result.

Overbought readings were ignored because the bigger trend was up. The Full Stochastic Oscillator moved below 20 in early September and early November. Subsequent moves back above 20 signaled an upturn in prices and continuation of the bigger uptrend. Similarly, a bullish divergence occurs when the market price makes a new low but the oscillator does not follow suit by moving to a new low reading. Bullish divergence indicates a possible upcoming market reversal to the upside. A bull trade setup happens when the stochastic indicator makes a higher high. Yet, the instrument’s price makes a lower high, signaling that momentum is growing and the price could move even higher.