Install our The Stochastic Oscillator: A Powerful Technical Indicator
The Stochastic Oscillator (Stoch) is a widely used technical indicator developed by George C. Lane in the 1950s. It helps traders and investors identify overbought and oversold conditions in the market, which can lead to price reversals or continuations.
The Stoch oscillator ranges from 0 to 100, with levels above 80 considered overbought and below 20 considered oversold. The indicator consists of three lines: the %K line (short-term), the %D line (long-term), and the %M line (moving average).
The %K line is a 14-period exponential moving average of the close minus the low, while the %D line is a 3-period exponential moving average of the %K line. The %M line is a simple moving average of the closing price over a set period.
How to Use the Stochastic Oscillator
To use the Stoch oscillator effectively, traders need to understand its two main signals:
- Overbought and oversold conditions: When the %K line crosses above the %D line or the %M line, it indicates an overbought condition. Conversely, when the %K line crosses below the %D line or the %M line, it indicates an oversold condition.
- Crossing of lines: When the %K and %D lines cross each other, it can be a buy or sell signal depending on the direction of the cross.
Example Usage
A trader may use the Stoch oscillator to identify overbought conditions in a short-term trend and adjust their stop-loss level accordingly. Alternatively, they might wait for an oversold condition to enter a long position.