What is the Stochastic Oscillator?

The Stochastic Oscillator is a technical analysis tool created by George Lane in the late ‘50s. The Stochastic Oscillator actually is a momentum indicator that compares current price levels to the High and Low previous price range. The Stochastic Oscillator clearly follows the speed of the momentum. The Stochastic Oscillator aims to indicate price reversals before they actually occur. Additionally it can be used by traders for identifying overbought price and oversold price levels.

 

Stochastic Oscillator Calculation

Stochastic Oscillator = 100{(Close – Low14)/(High14 - Low14)} = %D

-Low14 = the lowest of the 14 past periods
-High14 = the highest of the 14 past periods
-%D = 3-period moving average of Stochastic Oscillator

  

 

Stochastic Oscillator Default Settings

The default setting when using the Stochastic Oscillator is 14 periods (14,3,3). According to each timeframe, Stochastic Oscillator periods may concern daily, weekly, monthly or even intra-day periods.

 

The Use of the Stochastic Oscillator

The Stochastic Oscillator measures the current price level relative to the highest and to the lowest range for a certain period. It is best used for trading ranges and especially for identifying reversals. Check the following chart of the Stochastic Oscillator (settings 14,3,3,).

Chart: Stochastic Oscillator

Confirmation of the Stochastic Oscillator

As the Stochastic Oscillator doesn’t measure important variables as the volume activity, traders may use volume to confirm price reversals. Furthermore, the break of an important support / resistance level can provide reliable confirmation too.

 

Identifying Price Reversals

Stochastic Oversold Reversal:

-The oversold reversal is identified usually when the Stochastic Oscillator has turned up from the levels below 20.

-A bullish divergence occurs with a break of the price of Stochastic Oscillator above 50.

Stochastic Overbought Reversal:

-This reversal is identified usually when the Stochastic Oscillator has turned up from the levels above 80.

-A bearish divergence occurs with a break of the price of Stochastic Oscillator below 50.

 

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