Stochastic trading signals

The calculation of the stochastic indicator

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Measure content performance. Develop and improve products. List of Partners vendors. A stochastic oscillator is a momentum indicator comparing a particular closing price of a security to a range of its prices over a certain period of time. The sensitivity of the oscillator to market movements is reducible by adjusting that time period or by taking a moving average of the result. It is used to generate overbought and oversold trading signals, utilizing a 0— bounded range of values. The general theory serving as the foundation for this indicator is that in a market trending upward, prices will close near the high, and in a market trending downward, prices close near the low.

Setting the smoothing period to 1 is equivalent to plotting the Fast Stochastic Oscillator.

Indicators D ~ L

The stochastic oscillator is range-bound, meaning it is always between 0 and This makes it a useful indicator of overbought and oversold conditions. Traditionally, readings over 80 are considered in the overbought range, and readings under 20 are considered oversold.

However, these are not always indicative of impending reversal; very strong trends can maintain overbought or oversold conditions for an extended period. Instead, traders should look to changes in the stochastic oscillator for clues about future trend shifts. Stochastic oscillator charting generally consists of two lines: one reflecting the actual value of the oscillator for each session, and one reflecting its three-day simple moving average.

Because price is thought to follow momentum , the intersection of these two lines is considered to be a signal that a reversal may be in the works, as it indicates a large shift in momentum from day to day. Divergence between the stochastic oscillator and trending price action is also seen as an important reversal signal. For example, when a bearish trend reaches a new lower low, but the oscillator prints a higher low, it may be an indicator that bears are exhausting their momentum and a bullish reversal is brewing.

The stochastic oscillator was developed in the late s by George Lane. As designed by Lane, the stochastic oscillator presents the location of the closing price of a stock in relation to the high and low range of the price of a stock over a period of time, typically a day period.

Lane, over the course of numerous interviews, has said that the stochastic oscillator does not follow price or volume or anything similar. He indicates that the oscillator follows the speed or momentum of price. Stochastics attempts to predict turning points by comparing the closing price of a security to its price range. Prices tend to close near the extremes of the recent range just before turning points.

Slow Stochastic

In the case of an uptrend, prices tend to make higher highs, and the settlement price usually tends to be in the upper end of that time period's trading range. When the momentum starts to slow, the settlement prices will start to retreat from the upper boundaries of the range, causing the stochastic indicator to turn down at or before the final price high. Divergence-convergence is an indication that the momentum in the market is waning and a reversal may be in the making. The chart below illustrates an example of where a divergence in stochastics, relative to price, forecasts a reversal in the price's direction.

An event known as "stochastic pop" occurs when prices break out and keep going. This is interpreted as a signal to increase the current position, or liquidate if the direction is against the current position. From Wikipedia, the free encyclopedia. Retrieved 6 October Hoboken, NJ: Wiley.

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ISBN X. The last type of signal generated by the Stochastic Oscillator is called divergence signals. Stochastic Oscillator can generate both trend reversal and trend continuation divergence signals. The trend reversal signal is referred to as regular divergence signals, and the trend continuation signal is known as hidden divergence signals. The stochastic divergence signals tend to be the most powerful and reliable of all the different types of Stochastics generated signals.

When price makes a lower low, but the stochastic oscillator fails to confirm and instead makes a higher low, this is considered a Bullish Stochastic Divergence signal. When price makes a higher high, but the stochastic oscillator fails to confirm and instead make a lower high, this is considered a Bearish Stochastic Divergence signal.

Such conditions are known as a trend reversal divergence signal. As you can see in figure 4, the GBPUSD price continued to go down while the Stochastic Oscillator continued to move up, which generated a classic regular bullish divergence. This type of market condition is known as regular bearish divergence. When you find a regular divergence , you should discount the Stochastic Oscillator crossover signal as it would often turn out to be a false signal. For example, in figure 4, the first few Stochastic Oscillator signals generated during the regular bullish divergence proved to be false.

How Are Stochastics Used in Technical Analysis? With Examples -

Therefore, if you see a regular divergence, the best way to enter the market would be to apply a second uncorrelated technical indicator or price action signal. As you can see in figure 4, if you have waited for the GBPUSD price to break above the downtrend line after the formation of the regular bullish divergence, the trade would have yielded a profit, assuming you decided to exit after recognizing the bearish divergence afterwards. Hidden divergence is a trend continuation signal, and the Stochastic Oscillator can be used to find these occurances. If you learn to combine the crossover signal with hidden stochastic divergence, it can offer some good trading opportunities.

A hidden bullish divergence occurs when price is making a higher low, but the oscillator is making a lower low. And on the flip side, a hidden bearish divergence occurs when price is making a lower high, but the oscillator is making a higher high. For example, in figure 5, the Stochastic Oscillator value went below the previous low, but at the same time, the low of GBPUSD was higher than its previous low, which generated a hidden bullish divergence.

One approach to using Stochastic Oscillator trend continuation or hidden divergence signal is by combining it with the crossover signal. When the market generates a hidden divergence signal, and a Stochastic Oscillator crossover happens, the combination of these two can produce a high probability setup. Many Forex traders have experimented with trading with the stochastic indicator. When used correctly, this indicator can help you better gauge price movements in both trending and range bound markets. For example, a stochastic trading system is capable of generating reliable buy or sell crossover signals during a range bound market as well signal hidden divergences in a trending market.

And while the crossover signal does not work very well as a trend reversal signal during a strong uptrend, it can be very reliable as a trend reversal signal with regular divergences. The Stochastic Oscillator can be a versatile tool within your trading arsenal.