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Stochastic is a momentum oscillator. Since momentum tends to change direction before price, the stochastic oscillator is considered a ‘leading indicator’.

The stochastic is plotted as two lines: %K (called the fast line) and the %D (called the slow line). %D is a moving average of %K and so %K is more sensitive than %D. The default periods used to calculate the stochastic are 14,3, 3 where 14 is the period used to calculate the %K line, the second parameter is a smoothing factor and the last parameter is the number of periods used calculate %D. The sensitivity of the indicator to market movements can be varied by adjusting the time periods used in the calculations. Use shorter periods to make the indicator more sensitive and increase trading signals; or increase the period parameters to reduce sensitivity and produce fewer (but more reliable) trading signals.

The oscillator values fluctuate in a range between 0 and 100, and as such the indicator can be readily used to identify overbought and oversold levels. Readings above 80 occur when the market is trading near the top of its recent price range. Readings below 20 occur when the market is trading near the bottom of its recent price range.

There are a variety of ways to interpret the indicator, depending on the overriding market conditions or trend.

In a non-trending sideways-moving range bound market, technical analysts would consider a market overbought if the stochastic reading is above 80; and oversold if the stochastic is below 20. The indicator can remain above 80 and below 20 for some time, so it is generally suggested to wait for the stochastic to reverse before making a trade. A buy signal is generated if the stochastic moves up out of the oversold zone, crossing back above 20. A sell signal is generated when the stochastic moves down out of the overbought zone, falling back below 80.

On the other hand, in a trending market that is consistently making higher highs (or lower lows), stochastic readings above 80 (or below 20) are to be expected. A move above 80 followed by a reversal is not necessarily a sell signal if the bigger trend is bullish. By the same token, a move below 20 followed by a reversal is not necessarily a buy signal if the overall trend is bearish. When using stochastics, it is therefore important to determine the overall trend and trade in the direction of that trend. Ignore bearish overbought readings in an up-trending market. Ignore bullish oversold readings in a downtrending market.

Another method of using the stochastic is to trade when the stochastic %K line crosses the stochastic %D line. %K crossing above the %D is interpreted as a buy signal; whereas %K crossing below the %D is interpreted as a sell signal. Crossovers which occur above 80 (in the overbought zone) or below the 20 (in the oversold zone) tend to be more reliable signals than those occurring between the 20 to 80 levels. Crossovers can provide choppy signals, so should be considered with alternative indicators for confirmation.

A third method of using the indicator is to trade price / stochastic divergences - this is where the trend of the market’s price doesn’t agree with the trend of the stochastic and provides an indication that the current trend may be near ending. This method works on the assumption that when a divergence occurs between an indicator and price, the price generally changes direction to confirm the trend shown by the indicator.

Remember, the stochastic is a momentum indicator. Where price is in an uptrend and making new highs but the stochastic is failing to make new highs, this implies the price is running out of momentum and a price reversal is due. In such a situation, the stochastic falling below 50 would provide confirmation of the reversal and act as a sell signal.

Where price is in a downtrend (making new lows) but the stochastic forms a higher low, this implies that upside momentum is increasing and a price reversal is due. In such a situation, the stochastic rising above 50 would provide confirmation of the reversal and act as a buy signal.


Stochastic Formula

The Stochastic Oscillator formula uses the following parameters:

  •  %K Periods - the number of periods used to calculate the stochastic value.
  •  %K Slowing Periods - the slowing periods is used to smooth the stochastic value by summing the Stochastic typically over the last 1 to 3 periods. 1 is considered a fast stochastic and 3 is considered a slow stochastic.
  •  %D Periods - the number of periods used when calculating a moving average of the %K; it is typically used as a signal line with the %K.

The formula used to calculate the Stochastic %K value is:

where the default %K period is 14 and the %K Slow Period (sp) is 3.

The %D is the Simple Moving Average of the %K:

where the default %D period (d) is 3.

Stochastic Indicator

The Stochastic indicator can be displayed on the TimeToTrade charts. To add the Stochastic indicator to the TimeToTrade charts, go to the chart settings and click on the 'Add Indicator' button. Click on the search box and type the name of the indicator that you are looking for, or for example type Stochastic and scroll through the results:

Generic Indicator Settings 1.png

After adding the Stochastic indicator, within the chart settings, click on it to set the parameters and change colours.

Stochastic Alerts

Alerts can be set up to provide an Email or SMS text message notification of when your Stochastic indicator chart conditions have been met, backtest trading strategies or execute demo trades. To learn more:

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