Similar to other technical indicators, the Stochastic indicator helps traders on stock exchanges to make more accurate decisions. As a form of oscillator, Stochastic will provide you with information about the actual state of the market, from which you can promptly stop loss or take profit.
1. Understanding Stochastic:
Stochastic is an indicator in stock trading that compares the most recent closing price with the highest and lowest prices of a stock over a certain period of time. It provides moving numbers from 0 to 100 to provide an indication of a security’s momentum.
Closing prices tend to close near the high in an uptrend and near the low in a downtrend. If the price then closes off the high or low, then momentum is slowing down. Stochastics are most effective in wide trading ranges or slow moving trends. Two lines are plotted, the %K fast oscillation and the moving average of %K, commonly known as %D.
2. Identify overbought & oversold levels with Stochastic:
The misunderstanding of overbought and oversold is one of the biggest problems and mistakes in trading. Indicators Stochastic does not show oversold or overbought prices. It shows momentum.
Sometimes, traders will say that Stochastic above 80 means overbought and when Stochastic is below 20, price is considered oversold. And what traders mean is that an oversold market has a high probability of going down and vice versa. This is wrong and very dangerous!
Sometimes, when Stochastic is above 80, it means that the trend is strong and not that it is overbought and likely to reverse. A high Stochastic means that the price can close near the top and it continues to push higher. A trend in which Stochastic stays above 80 for a long time signals that momentum is running high and you should not be ready to short the market.
The image below shows the behavior of Stochastic in a long uptrend and a downtrend. In both cases, Stochastic went into “overbought” (above 80), “oversold” (below 20) and stayed there for quite some time, while the trend continued. Again, the belief that this indicator shows oversold / overbought is wrong and you will quickly run into problems trading this way. A high Stochastic value indicates that the trend has strong momentum and is NOT overbought.
3. Instructions for reading Stochastic:
Two roads Stochastic ranges from 0 to 100. The indicator has two distinct lines drawn at the values ’20’ and ’80’. The values in turn represent normal conditions. George Lane points out that in markets, prices follow momentum. Therefore, when the price is in the overbought zone, traders can look to sell as the %K line crosses the oversold and overbought %D market downwards. Similarly, when price is in the oversold territory, traders can look for buying opportunities when the %K line crosses the %D line upwards.
The above interpretation is ideal in different markets. Traders must be wary of Stochastic signals in strongly trending markets because indicator values can persist for long periods of time in overbought and oversold conditions. Traders also watch the Stochastic center line (value 50) because it indicates whether the prevailing trend is important or not. A qualifies as important if the Stochastic reading is above 50; conversely, a downtrend is considered important if the Stochastic indicator is below 50. In addition to reading the indicator, traders can also watch out for Stochastic divergences to find lucrative trading opportunities in the market. school.
4. Trade with Stochastic Signals
Here is how to trade the signals generated by the indicator Stochastic:
Overbought and oversold conditions: This is especially ideal in ranging markets where there are defined support and resistance levels. To place a buy order in the support zone, the Stochastic indicator must be below 20 and the %K line must cross the %D line or higher. Likewise, to place a sell order in the resistance zone, the indicator must be above 80 and the %K line must cross the %D line below.
Stochastic Straight Divergence: Stochastic Straight Divergence can help traders identify potential price reversals in the market early enough. A bullish divergence occurs when the price is making lower lows, but the indicator is making lower lows in the oversold zone. This is a signal to buy as the downtrend lacks momentum. A bearish divergence occurs when the price is making higher highs, but the Stochastic indicator is making lower highs in the overbought zone. This is a signal to sell because the uptrend lacks momentum.
Hidden Stochastic Divergence: While straight divergences help traders forecast potential market reversals, hidden Stochastic divergences help traders select optimal entry points in a potential market. trend after the retracement has occurred. In an uptrend, the idea is to look for a hidden divergence in the uptrend to place a buy order.
A hidden divergence in an uptrend occurs when price makes higher lows, but the Stochastic indicator makes lower lows around the oversold zone. In a downtrend, the idea is to look for a hidden divergence in the downtrend to place a sell order. A hidden bearish divergence occurs when price makes a lower high, but the Stochastic indicator makes a higher high around the overbought zone.
5. Professional Stochastic Indicator Strategies
Indicators Stochastic at its best when combined with other technical analysis tools. Here are some of the best combinations:
Stochastics and Pivot Points: Pivot Points are a popular indicator that creates multiple support and resistance lines. These lines can provide certain price zones where traders can watch for Stochastic trading signals. A high probability trading signal is sent when there is a confluence between the two indicators. For example, a high-quality long buy can be entered when the Stochastic buy signal appears above the Pivot Point support line.
Stochastics and Moving Averages: Moving Averages (MAs) are ideal for trading trending markets because they help smooth price action. When multiple moving averages are applied, traders will watch to identify trends. When combined with stochastics, traders can pick out great opportunities in trending markets.
The logic is to trade in the direction of the MA but eliminate potential false signals using Stochastic. For example, when the faster moving average crosses the slower moving average up, it means an uptrend is underway. Traders can then buy long when stochastics give buy signals.