How to Use the Stochastic Oscillator
Stochastic oscillator is one of the most important tools for the traders which helps them in comparing today’s price to its price range over a certain period of time. This helps in realizing the direction of a particular trend and where it might be ending. When the price moves to the upper end of the recent price range then it is categorized as an uptrend whereas when the price sinks, it is referred to as a downtrend. The two lines on the chart give a clear indication of the trend to all the traders.
This indicator was first discovered by Dr. George Lane in the mid-1950s and is popular amongst the traders till this day. There are three versions of the indicator called the full, slow, and fast. The preferred one out of the 3 is the slow one but this does not mean that the full and fast ones do not have a wide application. All three of them can be used in day trading and traders have resorted to them at different periods of time.
The stochastic oscillator is actually determined by taking into account the current price, the highs, and lows and the range of the 14 day period. The time frame is usually taken to be 14 but is the personal choice of the trader and he can change it accordingly to his needs or preferences. It is a versatile trading indicator and can cover efficiently both short and long periods.
How the Stochastic Oscillator Helps in Trading
The stochastic is scaled from the value of 0 to 100 and is one of the most efficient indicators of when the market is overbought or oversold. This can easily be determined because of the lines. When the stochastic lines are above the value of 80, this means that the market is overbought and when they are below 20, it shows that the market is oversold.
As a rule of thumb, the ideal time to sell is when the market is overbought and to buy is when the market is oversold. When a trend is being followed for a relatively long period of time, it is bound to move in the opposite direction. This is the law of market that a trend faces reversal after a trend persists for a long period of time.
It is easy to recognize the stochastic oscillator on the chart for the traders because the usual crossing of the lines indicate that a trade has happened. To determine the short crosses or the long crosses, it is seen that which line oscillates the intersection of the two. If the short line, which is usually red, crosses the long lines, which are usually blue, a short trade occurs. When the long lines cross through the short ones, a long trade happens.
Although the stochastic oscillator can be used for a variety of purposes but the major one is to know where the condition of the market can be overbought or oversold because this aids greatly the buying and selling processes.