Stochastic Oscillator Trading Strategy: Day Trading Tips

The stochastic oscillator is one of the technical instruments traders use to identify buy and sell signals and the trend direction. It measures market momentum and shows possible trend reversals. You can see the 5.3 stochastic setting on this 15 minute chart stock chart reacts quicker with extreme move to price and in some instances, crosses to the downside. Depending on how you use the oscillator in your trading, there may be validity to a smaller period setting. Each trader has to decide if the trade-off between quicker signals and more whipsaw to slower signals and smoother price movement, is worth it. The stochastic oscillator could be used by traders to identify momentum in price movements and determine potential entry and exit points.

Everything sounds clear, but when traders start their paths, it can be complicated to understand how to read the price chart. The stochastic oscillator works better when the market is consolidating, while the RSI is preferable Best settings for stochastic oscillator during trends. Divergence is an effective method that helps determine price reversals. Fortunately, the oscillator is set by default in MetaTrader 4 and most trading platforms, so you don’t need to download it separately.

Average Directional Index (ADX indicator)

Most importantly, let’s define the leading trend of the price movement. We will do it using the stochastic with 21, 7, and 7 parameters. The full version of the stochastic oscillator allows you to change all three parameters and even how %D stochastic is smoothed.

• The chart below shows the two indicators applied on a chart.
• Understand that whatever you choose, the more experience you have with the indicator will improve your recognition of reliable signals.
• Use the signals generated when the crossover happens in the extreme area (above 80 for sell signal and below 20 for buy signal).
• There is no best Stochastic Oscillator setting that will produce more wins than losses.
• The idea is that price action will tend to be bound by the bands and revert to the mean over time.

According to trading textbooks, courses, and etc. they will tell you that when you spot a divergence, it means a reversal is about to occur. As you can see, if you went short just because the market is overbought, it would have been a painful experience. I use 20-period because there are 20 trading days in a month, and a single line is enough to interpret what it means. Have you ever looked at a chart and noticed the Stochastic indicator (aka Stochastic oscillator) is overbought.

Meaning of Stochastic 14 3 3 indicator

This is a crucial part of the strategy because we only want to be trading in the direction of the higher time frame trend. Our team at Trading Strategy Guides.com has put a great deal of time into developing the best guide to Trading Multiple Time Frames – The Key to Successful Trading. The multiple time frame concept is important because it can give you a more robust reading of the current price action and more it can help you better time your entry and exit points. Different traders have a different mindset about using Stochastic.

Stochastic Oscillator is an indicator that was developed by George Lane, who was a well-known trader in the 1950s. The indicator is used to show the direction of the close relative to the high-low range of a certain duration. I use the stochastic RSI indicator for scalping by using it with the short term support or resistance or swing https://investmentsanalysis.info/ high’s and low’s in options. I can use stochastic indicator to time my entry or as entry trigger. The belief that the Stochastic shows oversold/overbought is wrong and you will quickly run into problems when you trade this way. A high Stochastic value shows that the trend has strong momentum and NOT that it is ready to turn around.

Using Stochastic Oscillator to identify overbought and oversold areas

Although the indicator is useful, it may provide the wrong signals during strong trends. When it’s inside these areas, the indicator doesn’t guarantee a 100% reversal. If the market trend is robust, there are risks the price won’t reverse. That’s why it’s worth looking at the indicator’s lines, as they were created for a reason.

As shown above, a sell signal emerged when the two lines intersected while being above the overbought level. A buy signal emerged when the same happened in the opposite direction. Instead, in technical analysis, they look at charts and use various technical indicators to help them predict. So if the market is in a downtrend and the price is at resistance, you can look to sell when the Stochastic crosses below 70. So, when it’s at overbought level (above 80), it means the market has strong bullish momentum. Now there’s nothing magical about it and you shouldn’t think too much about finding the best stochastic oscillator settings.

Stochastic indicator settings

Another way to use the stochastic oscillator is to look for divergences between the oscillator and the price of the asset. A bullish divergence occurs when the price of the asset is making lower lows, but the oscillator is making higher lows. This indicates that the momentum of the asset is starting to shift to the upside. When you put a stochastic oscillator on a chart, you will see two lines of different colors, the main and signal lines. Ideally, when the two lines are below 20, the pair is said to be oversold and when the lines are above 80, it is said to be overbought. As we have seen above, when the Stochastic is above 80 it means that the trend is strong and not that it is likely to reverse.