The Stochastic Oscillator is a momentum trading indicator that uses the velocity of a financial instrument’s fluctuation in price to provide buy/sell signals. Stochastics usually move before price changes and divergences in Stochastics can be used to predict financial instrument pricing reversals.
Benchmarks used to calculate Stochastics are:
- Most recent closing price
- Lowest price in the last X amount of trading periods
- Highest price in the last X amount of trading periods
- 3 day simple moving average
Overbought and Oversold Extremes
The Stochastics Oscillator is often used as a trading indicator for overbought and oversold extreme market conditions. According to general theory of Stochastics, the current market cycle trend determines whether a trading session’s closing price will be closer to the day’s high (uptrend) or low (downtrend).
Below is a chart showing Stochastics being used on a chart of the S&P 500:
You can see above on the chart where a buy signal threshold is made crossing the purple line (20) and where a sell signal is made crossing the yellow line (80).
Stochastics & Relative Strength Index (RSI)
Relative Strength Index (RSI) is another commonly used price momentum indicator that helps traders identify market trends. Both technical indicators use pre-established thresholds to determine buy/sell levels.
Some traders choose to use both trading indicators in tandem to receive a broader technical reading:
- Relative Strength Index (RSI) – A reading on the 0 to 100 scale below 30 or exceeding 70 are buy/sell signal levels
- Stochastics – A reading below 20 or exceeding 80 are buy/sell signal levels
Are you interested in using Stochastics or the RSI in a trade simulator?
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