WHAT IS STOCHASTIC? HOW TO READ AND TRADE ACCURATELY.

What is Stochastic? With all the knowledge that Coinstrategists has compiled, the article below will help you answer all related questions. Let’s explore and equip yourself with the necessary knowledge to be more confident in the world of cryptocurrency.

WHAT IS STOCHASTIC?

The Stochastic is an oscillator in technical analysis that compares the closing price and the previous trading range over a specific period of time. 

Developed by George C. Lane, the most important signal he identified is that bullish and bearish divergences form on the Stochastic that can predict the upcoming price reversal. In other words, it signals an earlier trend than the price movement. Therefore, it is considered a leading indicator. 

Since it fluctuates in a range, it can also be used to identify overbought or oversold price levels. Stochastic, like RSI, is a very effective indicator.

HOW TO CALCULATE THE STOCHASTIC INDICATOR

The Stochastic is plotted with two lines on the chart: 

The main indicator line called %K 

The signal line is called %D, which is the moving average (MA) of %K. 

When these two lines intersect, traders should look for an upcoming trend change. 

The downward diagonal of %K crossing over the signal line shows that the current closing price is close to the law of the indicator’s specified period compared to the previous three sessions. This is considered a bearish signal, as opposed to this is considered bullish.

Stochastic is calculated as follows: 

%K =[ (A-C) / (B-C) ] x 100 

In which: 

A is the nearest closing price. 

C is the lowest price during the specified time period.

B is the highest price during the specified period. 

The standard setting of %D is the 3-day SMA of %K. 

The default set period for Stochastic is 14 sessions and can be applied to any timeframe. 

 

Specific example of how to calculate when a standard setting is established:

As the chart on the indicator measures 14 periods. You will find the highest price of 1.48 and the lowest price of 1.448. The current closing price is 1,467 and is calculated by %K only: 

%K = [(1.4670 – 1.4480) / (1.4800 – 1.4480)] × 100 = 59.

HOW TO READ THE STOCHASTIC INDICATOR

The Stochastic is a range-bound indicator so it can be used to identify overbought and oversold market conditions.

If it is greater than 80, it reflects overbought market conditions. Below 20 reflects oversold market conditions. This indicator can only be in the range of 0 to 100, regardless of how quickly the price of the currency pair changes.

In the 14-session standard setting, the indicator above 80 indicates that the pair has been trading near the top of the trading range for the last 14 sessions. When it is below 20 indicates trading near the low of the trading range for the last 14 sessions.

Trend can rise or fall continuously. However, the stochastic indicator can remain in the oversold or overbought zone for a long time. So, always trade in the direction of the trend and wait for frequent oversold times in uptrends and overbought in downtrends.

USING STOCHASTIC IN TRADING

What is Stochastic? Below is some useful information about how to use stochastic that few people know.

– What is the MFI indicator?

– Join telegram channel here

TRADING AT OVERBOUGHT AND OVERSOLD CONDITIONS

As explained, Stochastic is commonly used to trade in overbought and oversold conditions or for bullish and bearish divergences.

The example below illustrates how to trade in the direction of the trend. When an uptrend is established, how trading occurs when oversold conditions occur.

Points (1), (2), (3) show that the market is oversold even though the price is still in an uptrend. That oversold level is created with each price correction. It signals that the uptrend may continue. 

Viable trading strategy is to enter when the %K line crosses the signal line from below. The stop loss level is just below the previous low. It is also important to wait for additional confirmation signals such as candlestick patterns, for example. Oscillators are known to sometimes give false signals.

DIVERGENCE UP AND DOWN

Divergences are used to identify the peaks and troughs of a trend. Helps decide when to enter and exit a position. In this respect, divergence is an early indicator of future price movements.

Usually, prices and technical indicators often move in the same direction. Divergence in the forex market occurs when the price and the indicator fail to simultaneously create new highs or lows. That is, they are diverting in different ways.

The example below is a bullish divergence case on a daily chart. While the price makes consecutive lower lows, the stochastic indicator does not follow the price movement.

Instead, it made higher levels. Different indicators and price redirection. As a result, the price has turned from a downtrend to the start of a new uptrend.

CONCLUSION

So in addition to indicator trading tools such as MA, MACD, Band,… you also know what is stochastic? Combining indicators is a good thing to do, because each indicator is relative and does not have absolute accuracy. Comparative analysis should be performed using different indicators to make accurate judgments.