How To Use a Stochastic Oscillator? Stochastic Oscillator In Technical Analysis

Knowing how to analyze a stochastic oscillator while trading forex helps you earn higher profits and minimize the number of losses you suffer. An upward market trend indicates high demand where investors buy, while a downward trend indicates high supply as investors sell their stock. Traders tend to buy excess securities when the market appears bullish and sell more when the market is bearish. 

The foreign exchange market keeps fluctuating, and a slight delay when entering or exiting a trade may lead to huge losses. How do you know the right time to dive into a trade or exit and take your profit? Studying the market indicators will help you buy or sell at the right time. A stochastic indicator shows variation in the closing price of a commodity to its different price range over a specified period.

What Is A Stochastic Oscillator? And What Role Does It Play?

In foreign exchange, a stochastic oscillator (SO) makes comparison between the price of a security during closure of a trade to the range of market prices within a time interval. The SO works on 14-period time frames which can be minutes, hours, or days. The lowest point in a period reads zero, while the highest point reads 100.

To calculate:

                      SO= {( Closing Price-lowest price)/ price range} x 100

From the above expression, SO is a percentage.

Here are the roles that a stochastic oscillatory chart plays in foreign exchange and trading indices.

Reflects Divergence in Price

When an asset’s price chart records a new high, the SO also strikes a new high. If the SO fails to establish a new high, the market experiences a price divergence with the two lines going to opposite directions and is likely to change to a downward trend.  Similarly, if the price chart hits a low but the SO fails to hit a corresponding low, the market is about to enter an upward trend.

A divergence indicates the reversal of the prevailing market trend, either upward or downward, but you should wait for market confirmation before entering a trade.

Observing diverging graphs will guide you in making an entry or an exit.

Indicates Oversold And Overbought Securities

The Stochastic Oscillator has values from 0-100; when the high in an uptrend goes beyond 80, that is overbought, and a sell signal develops. When the value hits a low below 20, that is oversold, and the system generates an uptrend.

Spotting overbought and oversold will help you make a buy or sell at the right time.

Reflects Crossovers

The point at which the fast and the sluggish stochastic lines meet is called crossover. The market is bullish if the SO moves above the crossover and bearish if the SO moves below the crossover. 

Crossover will help you know when to buy or sell.

How To Use the Stochastic Oscillator In Forex

It would be best to analyze the price chart before entry or exit of a trade. Here is what to look out for:

• A currency pair with a long bullish trend near resistance is about to make a reversal. Suppose you enter the market, you will make good gains within a short period. When the market confirms trend reversal, sell your securities and withdraw your profit.
• A coin pair with a long bearish trend near the support will start moving upwards. At this point, you should buy and hold your securities once the market confirms an upward trend.

• Look out for crossovers and analyze them before entering a trade. If the SO is above a crossover, wait for confirmation by the market before you sell. If it is below a crossover, buy and wait for a trend reversal to sell.
• Study the historical pattern in price fluctuation and link it with the present; this will enable you to make credible future predictions on the market trend.
• Read and learn from experts how to analyze and interpret the SO and consider the time interval of the chart.
• If you are trading on a small lot size, a shorter time range SO will work better for you. Setting your trade on a wide time range chart carries a high risk, unless you are an expert, avoid it.

Knowledge of stochastic oscillators and their use is insufficient to make you a good forex trader. It would help if you learned about the Japanese candlesticks and how to manage risk before you start trading foreign exchange and indices. Choice of the currency pair to trade in determines the profit you earn. You should update yourself on world news because they influence the trend that a currency pair takes.

Are Stochastic Oscillators Always Accurate?

Stochastic oscillators are pretty accurate since they reflect what is happening in the foreign exchange market at a time. The signals that SO displays are generated from the system and relay reliable information about the market. However, you should analyze other external factors that influence the market, such as political news and prevailing conditions in different regions, before you start to trade. 

Since it works on a percentage range, you should make an effort to acquaint yourself on how to use stochastic oscillator indicators and choose the good points to enter the market and when to exit. Above 80 and below 20 are ideal points to sell and buy, respectively. By analyzing the SO, you get the trend in previous securities value compared to the present value and how they influence the future value.

Sometimes a SO may produce a false signal, which is why you should enter a trade once you see the market confirmation about price reversal.

Key Takeaways

The stochastic oscillator relays signals according to the period range. A 14-hour indicator is different from a 14-day indicator. When analyzing the market from SO,  consider the time range before concluding about  the market. 

The crucial signals from SO are overbought and oversold. If you enter the market at this point, you will earn a good profit. 

Watch out for false signals and wait for market confirmation before entering a trade.