The DEFINITION of STOCHASTIC oscillator !

4 ก.ค. 2021

*Stochastic oscillator

The stochastic oscillator is a useful indicator when it comes to assessing momentum or trend strength. The stochastic oscillator, and oscillators in general, are presented in an easy to understand manner with clear buy and sell signals. However, an overreliance on these signals, without a deeper understanding of stochastic oscillators, is likely to end in frustration.

To avoid such frustration, new traders ought to have a solid understanding of the underlying mechanics of the stochastic oscillator viewed in relation to present market conditions.


**WHAT IS A STOCHASTIC OSCILLATOR?

A stochastic oscillator is a momentum indicator that calculates whether the price of a security is overbought or oversold when compared to price movement over a specified period. The oscillator essentially weighs up the most recent price level as a percentage of the range (highest high – lowest low) over a defined period of time.



***HOW DOES A STOCHASTIC OSCILLATOR WORK?

The stochastic oscillator presents two moving lines that ‘oscillate’ between two horizontal lines. The solid black line in the image below is called the %K and is while the red dotted line is a 3-period moving average of the %K line and It is called %D.

Price is shown to be ‘overbought’ when the two moving lines break above the upper horizontal line and ‘oversold’ once they break below the lower horizontal line.

The overbought line represents price levels that fit into the top 80% of the recent price range (high – low) over a defined period – with the default period often being ‘14’. Likewise, the oversold line represents price levels that fit into the bottom 20% of the recent price range.


****Timing entries:

Furthermore, the stochastic indicator provides great insight when timing entries. When both lines are above the ‘overbought’ line (80) and the %K line crosses below the dotted %D line, this is viewed as a possible entry signal to go short and the other way around is when the %K line crosses above the %D line when both lines are below the oversold line (20).

Additionally, you should not blindly trade based on overbought/oversold conditions alone. Traders need to understand the direction of the overall trend and filter trades accordingly. For example, when looking at the BTC/USD chart below, since the overall trend is down, traders should only look for short entry signals Further more, the stochastic indicator provides great insight when timing entries. When both lines are above the ‘overbought’ line (80) and the %K line crosses below the dotted %D line, this is viewed as a possible entry signal to go short and the other way around is when the %K line crosses above the %D line when both lines are below the oversold line (20).
Additionally, you should not blindly trade based on overbought/oversold conditions alone. Traders need to understand the direction of the overall trend and filter trades accordingly. For example, when looking at the USD/SGD chart below, since the overall trend is down, traders should only look for short entry signals at overbought levels. Only when the trend reverses or a trading range is well-established, should you look for long entries in oversold conditions.at overbought levels. Only when the trend reverses or a trading range is well-established, should you look for long entries in oversold conditions.


****STOCHASTIC OSCILLATORS: A SUMMARY

The stochastic indicator is a great tool for identifying overbought and oversold conditions over a specific time period. The stochastic oscillator is preferred by many traders when price is trading in a range because price itself is ‘oscillating’, leading to more reliable signals from the stochastic indicator. However, you need to avoid blindly shorting at overbought levels in upward trending markets; and going long in down trending markets purely based on oversold conditions shown by the indicator.


Note that sometimes the accuracy of BB is low (like the one shown with white flash) but most of the times it works fine.


We hope that you've learn something with this post .
Have a nice day and Good luck.