Forex trading is a complex and ever-evolving industry, and traders need to be equipped with the right tools and knowledge to make informed decisions. One of the most popular technical indicators used by traders is the stochastic oscillator. This indicator was developed by George Lane in the 1950s, and it has since become a staple in the trading community. In this article, we will explain what the stochastic oscillator is, how it works, and how traders can use it to make profitable trades.
What is the stochastic oscillator?
The stochastic oscillator is a momentum indicator that measures the relationship between the closing price of an asset and its price range over a specified period. The oscillator compares the current closing price to the high and low prices of the asset over a specified period, usually 14 days. The indicator is expressed as a percentage, with 0% representing the lowest point in the range, and 100% representing the highest point in the range.
How does the stochastic oscillator work?
The stochastic oscillator has two lines: the %K line and the %D line. The %K line is the main line, and it is calculated by subtracting the lowest low price over the specified period from the current closing price and dividing the result by the range of the price over the same period. The %D line is a moving average of the %K line and is usually calculated using a three-day simple moving average.
The oscillator is plotted on a chart with a range of 0-100, with levels at 20 and 80. When the stochastic oscillator is above 80, it is considered overbought, and when it is below 20, it is considered oversold. Traders use these levels to determine when to buy or sell an asset.
How can traders use the stochastic oscillator?
Traders use the stochastic oscillator to identify overbought and oversold conditions in the market. When the oscillator reaches the overbought level, it means that the asset is trading at a price higher than its actual value, and it is likely to experience a price correction. Conversely, when the oscillator reaches the oversold level, it means that the asset is trading at a price lower than its actual value, and it is likely to experience a price increase.
Traders also use the stochastic oscillator to identify divergences between the oscillator and the price of the asset. When the price of the asset is making higher highs, but the oscillator is making lower highs, it is called a bearish divergence. This indicates that the asset is losing momentum, and a price reversal is likely to occur. Conversely, when the price of the asset is making lower lows, but the oscillator is making higher lows, it is called a bullish divergence. This indicates that the asset is gaining momentum, and a price reversal is likely to occur.
Conclusion
The stochastic oscillator is a popular technical indicator used by traders to identify overbought and oversold conditions in the market. It is a momentum indicator that measures the relationship between the closing price of an asset and its price range over a specified period. Traders use the oscillator to identify divergences between the oscillator and the price of the asset, which can provide valuable insights into market trends. However, traders should use the stochastic oscillator in conjunction with other technical indicators and fundamental analysis to make informed trading decisions.
