Stochastic Oscillator is an indicator that is widely used by the professional trader to understand market volatility. It is the most well-known indicator used for indices, forex, stock trading. Below we’re going to give you some of the best Stochastic Oscillator settings that you can apply on your trading.
01 Jun 2020| AtoZ Markets – Stochastic Oscillator is a default trading indicator which you can be found in any trading platform. Its default parameters are (7, 10, 3), which can be changed by the user’s choice. Most of the professional trader trades with the default parameters by combining other indicators to find high accuracy trades. Stochastic Oscillator mostly used on a divergence, scalping, intraday trading, assure overbought/oversold and to buy/sell ensure.
What Is the Stochastic Oscillator?
In the 1950s, Dr. Gorge Lane invented the Stochastic Oscillator indicator. It invented to find buying and selling pressure of the market. It can also identify the cycle rotation that spare power within bulls and bears. Many traders take benefit of this reliable indicator. Stochastic Oscillator is a momentum indicator. It ranges between 100 and o by default. It shows the location of the close relative to the high-low range on a set number of parameters. Stochastic Oscillator contains two lines – %k is the slow Oscillator and %D is the moving average. Slowing is generally applied to the indicator’s default setting as a period of 3. Below is the default setting of the Stochastic Oscillator looks on the Meta Trader trading platform:
When Stochastic Oscillator applied on the default setting to the chart, it looks like this:
Stochastic Oscillator Formula
Stochastic Oscillator is combined components of lines “Slow Stochastic” and “Fast Stochastic”, which divided into three variants that monitor behind time and range of data level.
- Fast %K represents the closing price by comparing with previous periods.
- %K slows down fast %k with a simple moving average
- %D adds a second average
- C is the current closing price
- Lowest Low is the lowest low for the time frame
- Highest High is the highest high for the time frame
Uses of Stochastic Oscillator
Below are the basic uses of the Stochastic Oscillator indicator:
Overbought and Oversold levels
When the Stochastic reading is above 80 levels indicating the market is overbought. And below 20 indicates the market is oversold. Usually, the market gives sell signals when Stochastic lines are above 80 and return to below 80. In contrast, the market gives a buy signal when Stochastic lines are below 20 and return to above 20. Moreover, when the security price is near the top or bottom level, the Stochastic signals of Overbought and oversold by residing inside the range of the specific time frame.
Divergence happens when the asset price makes a new high or low without showing on Stochastic Oscillator. As an example, the price goes to a new high. Still, the Stochastic doesn’t move to a high reading accordingly. It is called bearish divergence. Bearish Divergence can signal a forthcoming market shift from a bullish trend to a bearish trend. The momentum of the bearish trend starting to collapse is showing by the Stochastic Oscillator’s failure to indicate new high reading together with the price. Likewise, the Stochastic doesn’t move to the low reading when the price is making a new low, that’s called bullish divergence. Bullish Divergence suggests a probable upcoming market switch to the upside.
It’s necessary to say, sometimes before the price is changing its direction oscillator can indicate a divergence signal. For example, Stochastic Oscillator is giving a divergence signal. But the price may go upward for a few amounts of trading session and after that turn to downward. That’s why Dr. Gorge Lane advised, to wait for some confirmation of the market shift before entering any trade. So, you shouldn’t trade relying on divergence only.
At which point the fast Stochastic line and the slow Stochastic line intersect that impose to crossover. %K line is the fast Stochastic line, and the slow Stochastic line is the %D line. The bullish crossover happens when the %K line intersects %D line and goes upon it. Besides, the intersection of the %K line to %D line from upside to downside Stochastic line indicates a bearish sell signal.
Stochastic Oscillator Limitations
The major disadvantage of the Stochastic Oscillator is the tendency of giving wrong signals. Particularly during stubborn and highly volatile trading situations. So it’s important to wait, for a confirmation of the signal from Stochastic Oscillator along with other technical indicators. Always keep in mind that Stochastic Oscillator invented mainly to measure power and weakness, not the trend. By using utmost readings from the Stochastic Oscillator indicating an overbought or oversold situation in the market, some traders target to reduce the oscillator’s tendency of giving false signals.
Best Stochastic Oscillator Settings
You have to choose first, how much noise of data you’re ready to accept for your trading method. The more knowledge you have with the indicator, it will enhance your sustaining of probable signals. Some professional traders choose the low setting for short-term trading or scalping. Some traders choose high setting for long-term trading. Because a highly smoothed outcome only responds to the key changes in the price action.
NZDUSD show different Stochastic Oscillator parameters rely on variants. After reaching the overbought and the oversold level, the fast line intersects the slow line then Cycle turns over. Moreover, the 5, 3, 3 parameters turn over buy and sell cycles repeatedly without reaching the overbought and oversold level. Besides, the 21, 7, 7 parameters work based on a longer period. But keep easing at a comparatively low level, and gives fewer buy and sell signals. Furthermore, the 21, 14, 14 parameters work on a giant dataset, rarely gives signals, and mostly near the key level.
Stochastic Oscillator and Pattern Analysis
When the price pattern shows regular barriers, Stochastic don’t have to reach the ultimate level to give reliable signals. While the deepest turns expected at the overbought and oversold levels, and crosses within the middle of the panel may rely on, then renowned support or resistance levels line up.
NZDUSD climb above the 50-day EMA after volatility decreased and created new support (1). It is forcing the Stochastic line to turn higher before reaching the oversold level. Also, it broke above the falling trend line and pulled back (2) triggering a bullish crossover at the middle point of the panel. Besides, the bullish rally reversed back to find support at the 50-day EMA (3), while triggering a third bullish move above the oversold level.
Many traders fail to understand the power of Stochastic because they’re confused with the right parameter. Different traders have a different mindset about using Stochastic. Some of them use the default setting only. And some of them use it by combining with the other indicators like – RSI, MACD, MA, EMA etc. You have to find what Stochastic Oscillator settings suit your psychology and trading style.
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