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Part 17: Technical Analysis – Stochastic oscillator
In our today’s article, we will be talking about an indicator used by and popular especially among the beginners. The popularity stems from being part of many strategies available at various websites, forums etc. Therefore it is easy for a beginner to get used to using it and follow it in spite of not knowing what its values actually mean.
Would you like to know what indicator I am talking about? What values does it show? What do these values mean and how to use the indicator? Continue reading to learn more!
Stochastic oscillator
This oscillator has been with us for a few decades. It was first described by George Lane in the 1950s. Stochastic indicator does not show the price of a given asset or the volume of trades made. It shows the speed of price changes. These changes are translated into figures on a scale from 0 to 100, and can be easily plotted in a chart.
This is what stochastic oscillator looks like
As mentioned above, the picture clearly shows that the values of the oscillator move i.e. “oscillate” between the values of 0 and 100. This is quite simple. But what do these values represent?
It’s simply as follows:
 When the line (the value of stochastic oscillator) is at the top (nearing 100, let’s say, 80+) this means that the asset is overbought.
 When the line is close to the bottom (below 20, let’s say), we may assume that the asset is oversold.
Overbought and oversold
The two terms can be translated simply as follows: overbought means that the asset is being excessively bought, oversold meanst he opposite: an excessively sold asset. This is exactly what the stochastic indicator shows. It shows the current demand for an asset. These indications may mean two things:
We can either expect a trend reversal (…turning the overbought into oversold) or the opposite move – status quo for some period of time. As clearly shown in the picture below, both options may happen.
Ignore the arrows down at the bottom of the stochastic oscillator
As you can see from the above picture, both cases do happen.
 As soon as the oscillator falls below the 20 line (at the start of the Fibonacci lines) the price went up. An oversold asset has turned into an overbought, leading to an instant rise.
 After the first rise above 80, the values remained unchanged for pretty long and the buyers continued buying. Instead of going down, the price went even higher.
How to use stochastic indicator?
This indicator can be used in two ways. You can use it as a tool for trade filtering. You can either trade with the trend (prices changes following the longterm trend) or in the opposite direction.

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Case 1:
Case 1: Twin peak, 100% rebound Fibonacci confirmed by the reversal of Stochastic indicator
This case shows how you can use the stochastic indicator to confirm signals. On the chart’s left side, you can see two arrows produced by the BERSI Scalp strategy. If you had used the stochastic oscillator as a filter, you would have avoided these two losses.
In the middle of the picture you can see two vertical lines. The both mark the spot where the trend reversed. Using stochastic oscillator, you could have filtered and seen that the price would eventually go back down. How easy, isn’t it?
Case 2:
Case 2: Stochastic indicator confirms continuing trend
In the second case, as you can see above, you can see the price once sharply go up and secondly plummet (both highlighted by vertical line).
The stochastic indicator shows that in one case the price is oversold and in the second, overbought. There is nothing easier than to follow the trend of buying or selling traders. If you follow the current trend, you will surely profit.
The signal in case 1 is even stronger because it was boosted by the BERSI Scalp arrow. I strongly recommend you to put Scholastic indicator in your arsenal.
More information
My personal recommendation is not to use the stochastic oscillator as the only signal for opening a trade. However I do recommend it for filtering. If you are about to open a trade, seeing some formation in the chart (or a signal in another strategy), you should first look what the stochastic indicator indicates. If the indicator does not confirm the move in your direction do not go for it. Instead, wait for a while for the next signal.
Thanks to filtering you can separate the good and the bad signals only to trade when the signal is strong enough i.e. to confirm by multiple indicators. The stochastic indicator is not the only indicator one should use as a filter. You can also use the ADX Indicator or RSI.
Further reading
Stochastic oscillator (stockcharts.com – more “scientific” explanation of indicator)
Binary options strategy that works (best binary options strategy.com – one of good TA strategies using stochastic oscillator)
Confirming rebound by indicators (xbinop.com)
Author
More about the author Step
I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options fulltime and thus gladly share my experiences with you. More posts by this author
Stochastics: An Accurate Buy and Sell Indicator
In the late 1950s, George Lane developed stochastics, an indicator that measures the relationship between an issue’s closing price and its price range over a predetermined period of time. To this day, stochastics is a favored technical indicator because it is easy to understand and has a high degree of accuracy in indicating whether it’s time to buy or sell a security.
key takeaways
 Stochastics is a favored technical indicator because it is easy to understand and has a high degree of accuracy.
 Stochastics is used to show when a stock has moved into an overbought or oversold position.
 it can be very beneficial to use stochastics and an oscillator like the relative strength index (RSI) together.
Price Action
The premise of stochastics is that when a stock trends upwards, its closing price tends to trade at the high end of the day’s range or price action. Price action refers to the range of prices at which a stock trades throughout the daily session. For example, if a stock opened at $10, traded as low as $9.75 and as high as $10.75, then closed at $10.50 for the day, the price action or range would be between $9.75 (the low of the day) and $10.75 (the high of the day). Conversely, if the price has a downward movement, the closing price tends to trade at or near the low range of the day’s trading session.
Stochastics is used to show when a stock has moved into an overbought or oversold position. Fourteen is the mathematical number most often used in the time mode. Depending on the technician’s goal, it can represent days, weeks, or months. The chartist may want to examine an entire sector. For a longterm view of a sector, the chartist would start by looking at 14 months of the entire industry’s trading range.
Relative Strength Index
Jack D. Schwager, the cofounder of Fund Seeder and author of several books on technical analysis, uses the term “normalized” to describe stochastic oscillators that have predetermined boundaries, both on the high and low sides. An example of such an oscillator is the relative strength index (RSI)—a popular momentum indicator used in technical analysis—which has a range of 0 to 100. It is usually set at either the 20 to 80 range or the 30 to 70 range. Whether you’re looking at a sector or an individual issue, it can be very beneficial to use stochastics and the RSI in conjunction with each other.
Stochastic Oscillator
Table of Contents
Stochastic Oscillator
Introduction
Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the highlow range over a set number of periods. According to an interview with Lane, the Stochastic Oscillator “doesn’t follow price, it doesn’t follow volume or anything like that. It follows the speed or the momentum of price. As a rule, the momentum changes direction before price.” As such, bullish and bearish divergences in the Stochastic Oscillator can be used to foreshadow reversals. This was the first, and most important, signal that Lane identified. Lane also used this oscillator to identify bull and bear setups to anticipate a future reversal. As the Stochastic Oscillator is rangebound, it is also useful for identifying overbought and oversold levels.
Calculation
The default setting for the Stochastic Oscillator is 14 periods, which can be days, weeks, months or an intraday timeframe. A 14period %K would use the most recent close, the highest high over the last 14 periods and the lowest low over the last 14 periods. %D is a 3day simple moving average of %K. This line is plotted alongside %K to act as a signal or trigger line.
Interpretation
The Stochastic Oscillator measures the level of the close relative to the highlow range over a given period of time. Assume that the highest high equals 110, the lowest low equals 100 and the close equals 108. The highlow range is 10, which is the denominator in the %K formula. The close less the lowest low equals 8, which is the numerator. 8 divided by 10 equals .80 or 80%. Multiply this number by 100 to find %K. %K would equal 30 if the close was at 103 (.30 x 100). The Stochastic Oscillator is above 50 when the close is in the upper half of the range and below 50 when the close is in the lower half. Low readings (below 20) indicate that price is near its low for the given time period. High readings (above 80) indicate that price is near its high for the given time period. The IBM example above shows three 14day ranges (yellow areas) with the closing price at the end of the period (red dotted) line. The Stochastic Oscillator equals 91 when the close was at the top of the range, 15 when it was near the bottom and 57 when it was in the middle of the range.
Fast, Slow or Full
There are three versions of the Stochastic Oscillator available on SharpCharts. The Fast Stochastic Oscillator is based on George Lane’s original formulas for %K and %D. In this fast version of the oscillator, %K can appear rather choppy. %D is the 3day SMA of %K. In fact, Lane used %D to generate buy or sell signals based on bullish and bearish divergences. Lane asserts that a %D divergence is the “only signal which will cause you to buy or sell.” Because %D in the Fast Stochastic Oscillator is used for signals, the Slow Stochastic Oscillator was introduced to reflect this emphasis. The Slow Stochastic Oscillator smooths %K with a 3day SMA, which is exactly what %D is in the Fast Stochastic Oscillator. Notice that %K in the Slow Stochastic Oscillator equals %D in the Fast Stochastic Oscillator (chart 2).
Fast Stochastic Oscillator:
Slow Stochastic Oscillator:
The Full Stochastic Oscillator is a fully customizable version of the Slow Stochastic Oscillator. Users can set the lookback period, the number of periods for slow %K and the number of periods for the %D moving average. The default parameters were used in these examples: Fast Stochastic Oscillator (14,3), Slow Stochastic Oscillator (14,3) and Full Stochastic Oscillator (14,3,3).
Full Stochastic Oscillator:
Overbought/Oversold
As a bound oscillator, the Stochastic Oscillator makes it easy to identify overbought and oversold levels. The oscillator ranges from zero to one hundred. No matter how fast a security advances or declines, the Stochastic Oscillator will always fluctuate within this range. Traditional settings use 80 as the overbought threshold and 20 as the oversold threshold. These levels can be adjusted to suit analytical needs and security characteristics. Readings above 80 for the 20day Stochastic Oscillator would indicate that the underlying security was trading near the top of its 20day highlow range. Readings below 20 occur when a security is trading at the low end of its highlow range.
Before looking at some chart examples, it is important to note that overbought readings are not necessarily bearish. Securities can become overbought and remain overbought during a strong uptrend. Closing levels that are consistently near the top of the range indicate sustained buying pressure. In a similar vein, oversold readings are not necessarily bullish. Securities can also become oversold and remain oversold during a strong downtrend. Closing levels consistently near the bottom of the range indicate sustained selling pressure. It is, therefore, important to identify the bigger trend and trade in the direction of this trend. Look for occasional oversold readings in an uptrend and ignore frequent overbought readings. Similarly, look for occasional overbought readings in a strong downtrend and ignore frequent oversold readings.
Chart 3 shows Yahoo! (YHOO) with the Full Stochastic Oscillator (20,5,5). A longer lookback period (20 days versus 14) and longer moving averages for smoothing (5 versus 3) produce a less sensitive oscillator with fewer signals. Yahoo was trading between 14 and 18 from July 2009 until April 2020. Such trading ranges are well suited for the Stochastic Oscillator. Dips below 20 warn of oversold conditions that could foreshadow a bounce. Moves above 80 warn of overbought conditions that could foreshadow a decline. Notice how the oscillator can move above 80 and remain above 80 (orange highlights). Similarly, the oscillator moved below 20 and sometimes remained below 20. The indicator is both overbought AND strong when above 80. A subsequent move below 80 is needed to signal some sort of reversal or failure at resistance (red dotted lines). Conversely, the oscillator is both oversold and weak when below 20. A move above 20 is needed to show an actual upturn and successful support test (green dotted lines).
Chart 4 shows Crown Castle (CCI) with a breakout in July to start an uptrend. The Full Stochastic Oscillator (20,5,5) was used to identify oversold readings. Overbought readings were ignored because the bigger trend was up. Trading in the direction of the bigger trend improves the odds. The Full Stochastic Oscillator moved below 20 in early September and early November. Subsequent moves back above 20 signaled an upturn in prices (green dotted line) and continuation of the bigger uptrend.
Chart 5 shows Autozone (AZO) with a support break in May 2009 that started a downtrend. With a downtrend in force, the Full Stochastic Oscillator (10,3,3) was used to identify overbought readings to foreshadow a potential reversal. Oversold readings were ignored because of the bigger downtrend. The shorter lookback period (10 versus 14) increases the sensitivity of the oscillator for more overbought readings. For reference, the Full Stochastic Oscillator (20,5,5) is also shown. Notice that this less sensitive version did not become overbought in August, September, and October. It is sometimes necessary to increase sensitivity to generate signals.
Bull/Bear Divergences
Divergences form when a new high or low in price is not confirmed by the Stochastic Oscillator. A bullish divergence forms when price records a lower low, but the Stochastic Oscillator forms a higher low. This shows less downside momentum that could foreshadow a bullish reversal. A bearish divergence forms when price records a higher high, but the Stochastic Oscillator forms a lower high. This shows less upside momentum that could foreshadow a bearish reversal. Once a divergence takes hold, chartists should look for a confirmation to signal an actual reversal. A bearish divergence can be confirmed with a support break on the price chart or a Stochastic Oscillator break below 50, which is the centerline. A bullish divergence can be confirmed with a resistance break on the price chart or a Stochastic Oscillator break above 50.
50 is an important level to watch. The Stochastic Oscillator moves between zero and one hundred, which makes 50 the centerline. Think of it as the 50yard line in football. The offense has a higher chance of scoring when it crosses the 50yard line. The defense has an edge as long as it prevents the offense from crossing the 50yard line. A Stochastic Oscillator cross above 50 signals that prices are trading in the upper half of their highlow range for the given lookback period. This suggests that the cup is half full. Conversely, a cross below 50 means that prices are trading in the bottom half of the given lookback period. This suggests that the cup is half empty.
Chart 6 shows International Gaming Tech (IGT) with a bullish divergence in FebruaryMarch 2020. Notice how the stock moved to a new low, but the Stochastic Oscillator formed a higher low. There are three steps to confirming this higher low. The first is a signal line cross and/or move back above 20. A signal line cross occurs when %K (black) crosses %D (red). This provides the earliest entry possible. The second is a move above 50, which puts prices in the upper half of the Stochastic range. The third is a resistance breakout on the price chart. Notice how the Stochastic Oscillator moved above 50 in late March and remained above 50 until late May.
Chart 7 shows Kohls (KSS) with a bearish divergence in April 2020. The stock moved to higher highs in early and late April, but the Stochastic Oscillator peaked in late March and formed lower highs. The signal line crosses and moves below 80 did not provide good early signals in this case because KSS kept moving higher. The Stochastic Oscillator moved below 50 for the second signal and the stock broke support for the third signal. As KSS shows, early signals are not always clean and simple. Signal line crosses, moves below 80, and moves above 20 are frequent and prone to whipsaw. Even after KSS broke support and the Stochastic Oscillator moved below 50, the stock bounced back above 57 and the Stochastic Oscillator bounced back above 50 before the stock continued sharply lower.
Bull/Bear SetUps
George Lane identified another form of divergence to predict bottoms or tops, dubbed “setups.” A bull setup is basically the inverse of a bullish divergence. The underlying security forms a lower high, but the Stochastic Oscillator forms a higher high. Even though the stock could not exceed its prior high, the higher high in the Stochastic Oscillator shows strengthening upside momentum. The next decline is then expected to result in a tradable bottom.
Chart 8 shows Network Appliance (NTAP) with a bull setup in June 2009. The stock formed a lower high as the Stochastic Oscillator forged a higher high. This higher high shows strength in upside momentum. Remember that this is a setup, not a signal. The setup foreshadows a tradable low in the near future. NTAP declined below its June low and the Stochastic Oscillator moved below 20 to become oversold. Traders could have acted when the Stochastic Oscillator moved above its signal line, above 20 or above 50, or after NTAP broke resistance with a strong move.
A bear setup occurs when the security forms a higher low, but the Stochastic Oscillator forms a lower low. Even though the stock held above its prior low, the lower low in the Stochastic Oscillator shows increasing downside momentum. The next advance is expected to result in an important peak. Chart 9 shows Motorola (MOT) with a bear setup in November 2009. The stock formed a higher low in lateNovember and early December, but the Stochastic Oscillator formed a lower low with a move below 20. This showed strong downside momentum. The subsequent bounce did not last long as the stock quickly peaked. Notice that the Stochastic Oscillator did not make it back above 80 and turned down below its signal line in midDecember.
Conclusion
While momentum oscillators are best suited for trading ranges, they can also be used with securities that trend, provided the trend takes on a zigzag format. Pullbacks are part of uptrends that zigzag higher. Bounces are part of downtrends that zigzag lower. In this regard, the Stochastic Oscillator can be used to identify opportunities in harmony with the bigger trend.
The indicator can also be used to identify turns near support or resistance. Should a security trade near support with an oversold Stochastic Oscillator, look for a break above 20 to signal an upturn and successful support test. Conversely, should a security trade near resistance with an overbought Stochastic Oscillator, look for a break below 80 to signal a downturn and resistance failure.
The settings on the Stochastic Oscillator depend on personal preferences, trading style and timeframe. A shorter lookback period will produce a choppy oscillator with many overbought and oversold readings. A longer lookback period will provide a smoother oscillator with fewer overbought and oversold readings.
Like all technical indicators, it is important to use the Stochastic Oscillator in conjunction with other technical analysis tools. Volume, support/resistance and breakouts can be used to confirm or refute signals produced by the Stochastic Oscillator.
Using with SharpCharts
As noted above, there are three versions of the Stochastic Oscillator available as an indicator on SharpCharts. The default settings are as follows: Fast Stochastic Oscillator (14,3), Slow Stochastic Oscillator (14,3) and Full Stochastic Oscillator (14,3,3). The lookback period (14) is used for the basic %K calculation. Remember, %K in the Fast Stochastic Oscillator is unsmoothed and %K in the Slow Stochastic Oscillator is smoothed with a 3day SMA. The “3” in the Fast and Slow Stochastic Oscillator settings (14,3) sets the moving average period for %D. Chartists looking for maximum flexibility can simply choose the Full Stochastic Oscillator to set the lookback period, the smoothing factor for %K and the moving average for %D. The indicator can be placed above, below or behind the actual price plot. Placing the Stochastic Oscillator behind the price allows users to easily match indicator swings with price swings. Click here for a live example.
Suggested Scans
Stochastic Oscillator Oversold Upturn
This scan starts with stocks that are trading above their 200day moving average to focus on those that are in a bigger uptrend. Of these, the scan then looks for stocks with a Stochastic Oscillator that turned up from an oversold level (below 20).
Stochastic Oscillator Overbought Downturn
This scan starts with stocks that are trading below their 200day moving average to focus on those that are in a bigger downtrend. Of these, the scan then looks for stocks with a Stochastic Oscillator that turned down after an overbought reading (above 80).
For more details on the syntax to use for Stochastic Oscillator scans, please see our Scanning Indicator Reference in the Support Center.
Further Study
John Murphy’s Technical Analysis of the Financial Markets has a chapter devoted to momentum oscillators and their various uses, covering the pros and cons as well as some examples specific to the Stochastic Oscillator.
Martin Pring’s Technical Analysis Explained explains the basics of momentum indicators by covering divergences, crossovers, and other signals. There are two more chapters covering specific momentum indicators, each containing a number of examples.
Technical Analysis of the Financial Markets John J. Murphy 
Technical Analysis Explained Martin Pring 
Additional Resources
Stocks & Commodities Magazine Articles
The Stochastic Oscillator by Joe Luisi
Nov 1997 – Stocks & Commodities

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