Trading with Stochastic Oscillator

What Is Stochastic Oscillator?

The stochastic oscillator developed by George C. Lane at the end of the 1950s is a valuable trading tool for predicting trend reversals. This indicator identifies overbought and oversold levels of security by measuring price momentum, which is the rate of acceleration in price movement.

The idea behind the stochastic oscillator is that the momentum often changes before the price changes direction. As a result, this indicator can outpace the price movement, giving traders an advantage.

The stochastic oscillator is a helpful tool for experienced and novice traders. Combined with other technical analysis tools such as moving averages, trendlines, and support and resistance levels, the stochastic oscillator can be a powerful instrument to improve trading accuracy and identify the best entry and exit points.

How Does Stochastic Oscillator Work?

The indicator measures the recent price close in relation to the highest and the lowest point of the range the security traded in over a defined number of past periods. The standard number of periods used for measurement is 14. For example, on a daily chart, this will be 14 days. On an hourly chart, this will be 14 hours, etc.

The stochastic indicator is a two-line indicator that traders can use on any chart. These two lines are %K and %D lines, which move between 0 and 100.

Stochastic - example.png

  • When the stochastic indicator is high, the instrument’s price closes near the top of the 14-period range.
  • On the contrary, when the indicator is low, the price closes near the bottom of the 14-period range.
  • The general rule for the stochastic indicator is that in an upward-trending​​ market, prices will close near the high. In contrast, prices will close near the low in a downward-trending market. If the closing price slips away from the high in a bull market or the low in a bear market, momentum​​ is slowing, and a reversal might begin soon.

Stochastic Oscillator Formula

The stochastic oscillator formula is:

%K = (Current Close - Lowest Low)/(Highest High - Lowest Low) * 100;

%D = 3-day SMA of %K.

Where:

  • "Current Close" represents the security's closing price for the current period;
  • "Lowest Low" is the lowest price the security has reached over the specified period;
  • "Highest High" is the highest price the security has reached over the specified period.

%K is the fast stochastic indicator, as it reacts more quickly to price changes. %D is the "slow" stochastic indicator, as it is usually a 3-period moving average of %K.

Stochastic Indicator Settings

The Stochastic oscillator is a default instrument of MetaTrader 4 and MetaTrader 5. You can add it to the chart by clicking “Insert” – “Indicators” – “Oscillators” and then choosing “Stochastic Oscillator.”

2 (3).png

The default settings are 5, 3, 3. Other commonly used settings for Stochastic include 14, 3, 3, and 21, 5, 5. Stochastic is often referred to as Fast Stochastic with a setting of 5, 4, Slow Stochastic with a setting of 14, 3, and Full Stochastic with a setting of 14, 3, 3.

Fast Stochastic responds more quickly to market price changes, while Slow Stochastic reduces the number of false crossovers and thus filters out some false signals. It’s up to you to choose the parameters you want.

Reading Stochastic Indicator

As we mentioned above, a Stochastic oscillator moves between 0 and 100. However, the price usually doesn't reach these extremes. Thus, traders typically use 20 and 80 levels as marks for overbought and oversold areas.

If an indicator rises above 80, the instrument trades near the top of its high-low range and is currently overbought. Vice versa, if an indicator falls below 20, the instrument trades near the bottom of its high-low range and is currently oversold. Usually, when a price reaches overbought and oversold areas, a reversal is about to happen.

If the oscillator moves above 50, the instrument trades within the upper portion of the trading range, with bulls dominating the market. On the contrary, if the oscillator moves below 50, the instrument trades in the lower portion of the trading range, with bears dominating the market.

Overbought and oversold levels are useful for predicting trend reversals.

How to trade with Stochastic Oscillator

Like any other indicator, Stochastic doesn’t give signals that are 100% profitable. There are two ways to make the signals of this indicator more precise:

Use the signals generated when the crossover happens in the extreme area (above 80 for the sell signal and below 20 for the buy signal).

3 (2).png

Consider the trend on a larger timeframe and trade in line with it. For example, if you use Stochastic on H1, check the trend on H4. If there’s a strong downtrend, don’t take the buy signals, as the price may stay in the overbought area for extended periods. Instead, focus on the sell signals generated by Stochastics, and you will benefit from trend trading.

4 (1).png

In addition, as with other oscillators, pay attention to the situations when the Stochastic Oscillator forms a divergence from the price chart. A sell signal occurs when the price makes a higher high but the Stochastic forms a lower high (bearish divergence). On the contrary, a buy signal appears when the price makes a lower low, while Stochastic forms a higher low.

5 (1).png

It’s also recommended to use the Stochastic Oscillator combined with other technical analysis tools, such as Moving Averages, Heiken Ashi, Alligator, etc.

Summary

A stochastic oscillator is a powerful tool for traders that helps to identify potential market reversals and momentum shifts. You can gain an edge in the markets by understanding how it works and how to use it in your trading strategy. However, it's important to remember that no technical indicator is foolproof, and managing your risk and trade with discipline is always important.

Frequently asked questions

  • How to open an FBS account?

    Click the ‘Open account’ button on our website and proceed to the Personal Area. Before you can start trading, pass a profile verification. Confirm your email and phone number, get your ID verified. This procedure guarantees the safety of your funds and identity. Once you are done with all the checks, go to the preferred trading platform, and start trading. 

  • How to start trading?

    If you are 18+ years old, you can join FBS and begin your FX journey. To trade, you need a brokerage account and sufficient knowledge on how assets behave in the financial markets. Start with studying the basics with our free educational materials and creating an FBS account. You may want to test the environment with virtual money with a Demo account. Once you are ready, enter the real market and trade to succeed.

  • How to withdraw the money you earned with FBS?

    The procedure is very straightforward. Go to the Withdrawal page on the website or the Finances section of the FBS Personal Area and access Withdrawal. You can get the earned money via the same payment system that you used for depositing. In case you funded the account via various methods, withdraw your profit via the same methods in the ratio according to the deposited sums.

Latest news

EURUSD: Seeking liquidity in weekly selling zones. Key intraday levels.

Bearish scenario: Sell below 1.0820 / 1.0841... Bullish scenario: Buy above 1.0827...

XAUUSD: In supply zone. How far to consider the next retracement?

Bearish scenario: Sell below 2200 / 2194 ... Nearest bullish scenario: Buy above 2197... Bullish scenario after retracement: Consider buys around each indicated demand zone

CAD: Markets Await GDP Release

During the Asian session on Wednesday, the USD/CAD pair rebounded after two days of losses, reaching around 1.3590. This uptick is fueled by a stronger US dollar and lower crude oil prices, which put pressure on the Canadian dollar. The decline in Western Texas Intermediate (WTI) oil prices to approximately $80.70 is attributed to...

Deposit with your local payment systems

Data collection notice

FBS maintains a record of your data to run this website. By pressing the “Accept” button, you agree to our Privacy policy.

Callback

A manager will call you shortly.

Change number

Your request is accepted.

A manager will call you shortly.

Next callback request for this phone number
will be available in

If you have an urgent issue please contact us via
Live chat

Internal error. Please try again later

Don’t waste your time – keep track of how NFP affects the US dollar and profit!

You are using an older version of your browser.

Update it to the latest version or try another one for a safer, more comfortable and productive trading experience.

Safari Chrome Firefox Opera