Here, we continue to showcase the most popular and widely used technical indicators in the trading world.

We continue the review of the most popular technical indicators and in today’s post, we would like to introduce the Stochastic Oscillator and to further explain how it should be interpreted and integrated with your trade analysis for better results.

A stochastic indicator on the chart.

The stochastic oscillator is a momentum indicator comparing the closing price of a token to the range of its prices over a certain period. The sensitivity of the oscillator to market movements is reducible by adjusting that time or by taking a moving average of the result.

The general theory serving as the foundation for this indicator is that in a market trending upward, prices will close near the high, and in a market trending downward, prices close near the low. Transaction signals are created when the %K crosses through a three-period moving average, which is called the %D.

So let’s take a look at:

- How does the indicator work,
- Where to look at the chart and what is there to see,
- The main strategies and what signals they give,
- What is Stochastic RSI and how it differs from the base Stochastic Oscillator
- How to connect the indicator to your custom TradingView signals so that the bot trades according to your strategy.

Principle of operation

The Stochastic Oscillator is useful in highly volatile markets. *It will be less useful when the market moves sideways and candles are almost identical in value over a period. *The indicator triggers a buy or sell signal when the price of an asset for several timeframes quickly moves in one direction, and then slows down. This is a signal for a possible change in trend.

The market entry or exit point is the moment when the value loses speed or the so-called **momentum** "

But first a small introduction.

**Once upon a time ...**

The stochastic oscillator was developed in the late 1950s by George Lane. As designed by Lane, the stochastic oscillator presents the location of the closing price of a stock in relation to the high and low range of the price of a stock over a period, typically a 14-day period. Lane, over the course of numerous interviews, has said that the stochastic oscillator does not follow price or volume or anything similar. He indicates that the oscillator follows the speed or momentum of price. Lane also reveals in interviews that, as a rule, the momentum or speed of the price of a stock changes before the price changes itself. In this way, the stochastic oscillator can be used to foreshadow reversals when the indicator reveals bullish or bearish divergences. This signal is the first, and arguably the most essential, trading signal Lane identified.

**Overbought vs. Oversold**

Lane also expressed the vital role the stochastic oscillator can play in identifying overbought and oversold levels because it is range bound. This range – from 0 to 100 – will remain constant, no matter how quickly or slowly a security advances or declines. Considering the most traditional settings for the oscillator, 20 is typically considered the oversold threshold and 80 is considered the overbought threshold. However, the levels are adjustable to fit security characteristics and analytical needs. Readings above 80 indicate a security is trading near the top of its high-low range; readings below 20 indicate the security is trading near the bottom of its high-low range.

**Formula**

Stochastic has only 2 lines,% K and% D. They are calculated like this:

*(Current closing price - Lowest price) / (Highest price - Lowest price) * 100 =% K line.**Simple moving average (SMA) for 3 days from% K = line% D*

Strategies and signals

What to see when looking at the Stochastic

The stochastic oscillator consists of two lines, they are displayed in a scale from 0 to 100.

- The first line, also known as% K, displays the current closing price in relation to the price range you have selected.
- The second line (% D) is the usual simple moving average (SMA), calculated on the basis of the% K line.

The lines% D and% K on the chart

Perhaps you still are not very clear.

**Stochastic Strategies**

Overbought and oversold

This is the primary signal that Stochastic generates.

- All above 80 - overbought.
- Everything below 20 is oversold.

Oversold and overbought areas on the chart

As you can see, these values form a band. You can change the settings but most traders use 80/20 or 70/30.

As you remember, Stochastic is effective at times of rising or falling prices and trend reversal when the lines go beyond the overbought or oversold zone.

*The output of the Stochastic lines beyond the boundaries of the colored zone confirms a strong trend, and does not refute it.*

On the chart it looks like this:

**When the trend goes up:**

Stochastic work on an uptrend

**When the trend goes down:**

Stochastic work on a downtrend

*If there is no trend, and the lines still cross the overbought or oversold limits, then it is possible that this has no meaning*

**Divergence**

Divergence is formed when the price goes one way, and the Stochastic in the opposite direction. This typically indicates a potential radical price movement.

**Supposed growth: divergence on price fall**

Look, the price falls, and the Stochastic takes off. This is a divergence. As a result, the Stochastic Oscillator should trigger a buy.

Oscillator. Divergence on price fall

**Supposed fall: divergence on the growth of coins**

Here the mirror situation works: the price rises and the indicator goes down in the opposite direction. And again it turns out to be right:

Stochastic Oscillator. Divergence on coin growth

**Where the****Price reversal ****is hidden:**

Picking the right entry or exit point is, of course, every trader’s dream. In the following diagram, we will show how to predict the maximum discrepancy in price-action/stochastic divergence.

The price goes down, the Stochastic shows a move up - a typical divergence. Wait until the price reaches the lowest level - it will reach the bottom plateau - and trigger a buy

Stochastic Oscillator. Minimum divergence when the price falls

**We find it on the price increase: maximum vs minimum**

The price reaches the ceiling, which is no longer able to break through, and the Stochastic, in contrast to it, goes to the very minimum. Such a maximum discrepancy is a sign that the price will reverse very soon.

Stochastic Oscillator. Maximum divergence on a rise

**Stochastic RSI (RSI)**

The StochRSI is an indicator used in technical analysis that ranges between zero and one and is created by applying the Stochastic Oscillator formula to a set of Relative Strength Index (RSI) values rather than standard price data. Using RSI values within the Stochastic formula gives traders an idea of whether the current RSI value is overbought or oversold - a measure that becomes specifically useful when the RSI value is confined between its signal levels of 20 and 80.

The StochRSI is the second derivative of price, which means that it doesn't always look similar to the price. The indicator deemed to be oversold when the value drops below 0.20, meaning the RSI value is trading at the lower end of its predefined range, and that the short-term direction of the underlying security may be nearing a correction. Conversely, a reading above 0.80 suggests the RSI may be reaching extreme levels and could be used to signal a pullback in the underlying security.

In addition, the StochRSI can be used to identify short-term trends by looking at it in the context of an oscillator with a centerline at 0.50. When the StochRSI is above 0.50, the security may be seen as trending higher and vice versa when it's below 0.50. The downside to using the StochRSI for these reasons is that it tends to be quite volatile, which means that some smoothing may be needed. Some traders will take a moving average of the StochRSI to reduce the volatility and make the indicator more useful. For example, a 10-day simple moving average of the StochRSI can produce an indicator that's much smoother and more stable.

Stochastic RSI and the base Stochastic on the chart

**How to connect personal signals Trading view to your bot**

Example of creating a notification for stochastic

1. According to the instructions of personal signals on the creation and configuration of the bot.

2. On the TV chart add this indicator.

3. Right-click on it and add a notification.

4. Choose the condition for the opening of the transaction: the intersection of% K and% D or the rise or fall to the oversold or overbought zone. Let our bot open the long transaction when it falls to the oversold zone:

5. Insert the bot message to start the transaction in the alert message.

6. Done!

**So, what we learned today**

- Stochastic Oscillator - one of the most popular indicators – indicates at what point to expect a trend reversal.
- It works with a strong trend and is not useful with low volatility.
- Signals to enter or exit the market lie in the overbought and oversold areas and with divergence.
- An exit of Stochastic lines to overbought and oversold zones informs that the trend will continue.
- Divergence is formed when the price goes one way, and the Stochastic - the other.
- Divergence shows that soon the trend will change direction to what the indicator shows. The price falls, and Stochastics shows growth - then growth is coming. The rate grows, and the indicator falls - then the coin will very soon fall.
- In a price uptrend, the point of the trend reversal occurs at the moment of maximum divergence. In a downtrend - at the point of minimum divergence. That is, when the coin “rests” against the ceiling or the bottom and the first deals with orders that reverse the trend appear, it indicated that a reversal is possible.
- The Stochastic RSI is similar with Stochastic, only smoother.
- Stochastic RSI works well on 15-minute charts.
- Stochastic Oscillator is not sufficient to make a buy or sell decisions. It is essential to use it in conjunction with other indicators to confirm trend reversals.

Practice is good, and practice plus a trading bot, and feedback is much better. Therefore, customize your bot using Stochastic personal signals and share your experience or ask for advice in our telegram chat.

*We wish you all the best!**10% discount on promo code “USERNEW” **3commas **team.*

## Comments

0 comments

Please sign in to leave a comment.