Stochastic Oscillator: Ultimate Guide & Best Settings

The RSI is generally more useful for trending markets and stochastic oscillators in sideways or choppy markets. However, the stochastic momentum index (SMI) shows the closing momentum relative to the median high or low range for a particular time period. I use the stochastic RSI indicator for scalping by using it with the short term support or resistance or swing high’s and low’s in options. It’s also recommended to use the Stochastic Oscillator combined with other technical analysis tools, such as Moving Averages, Heiken Ashi, Alligator, etc.

To implement the technical indicator in the chart, press “Indicators” and choose “Stochastic Oscillator” from the dropdown list. For beginner traders, check the step-by-step explanation using the example of the Bollinger Bands indicator here. Technically, D isn’t stochastic – it is a derivative from %K.

What Is the Best Setting for a Stochastic Oscillator?

For example, if the stochastic oscillator is crossing above 20 on the 4-hour chart, you should look for a bullish candlestick pattern or a breakout of resistance. Third, you should look for exit signals on the shortest time frame. For example, if the stochastic oscillator is crossing below 80 on the 1-hour chart, you should look for a bearish candlestick pattern or a breakdown of support. The stochastic in technical analysis is a momentum indicator, which means that it doesn’t reflect a trend like common trend tools, like moving averages. It measures the strength of a price, allowing traders to predict price reversals. Both are stochastic tools that are used to determine momentum in any given market condition.

• When the market price falls, relocate the stop-loss to a breakeven zone.
• For further affirmative signals, traders may also wait for the %D line to rise above 20.
• A trader could go long once %K (grey line) crosses %D (orange line) bottom-up (1).
• It’s also recommended to use the Stochastic Oscillator combined with other technical analysis tools, such as Moving Averages, Heiken Ashi, Alligator, etc.
• The full version of the stochastic oscillator allows you to change all three parameters and even how %D stochastic is smoothed.
• Candlestick patterns are used to identify potential changes in market direction.

A bearish divergence forms when price records a higher high, but the Stochastic Oscillator forms a lower high. This shows less upside momentum that could foreshadow a bearish reversal. Once a divergence takes hold, chartists should look for a confirmation to signal an actual reversal. A bearish divergence can be confirmed with a support break on the price chart or a Stochastic Oscillator break below 50, which is the centerline. A bullish divergence can be confirmed with a resistance break on the price chart or a Stochastic Oscillator break above 50. There are three versions of the Stochastic Oscillator available on SharpCharts.

Stochastic Indicator Calculation & Formula

This allows traders to determine correction and reversal features within a trading range using the most recent closing price that helps define entry points. There are no strict rules on what smooth settings to use with this momentum indicator, but it’s vital to consider their differences for successful trading experiments. Some of the stochastic momentum indicator’s pros are its reliable entry and exit signals when the market is flat. Still, even in such a case, it’s worth using the SMI with other technical tools.

Since the signal occurred below 20%, the risk of it being false is low. Here, it’s worth opening a long trade near the highest point of the crossover candlestick. On the chart above where the lowest prices are, I marked the entry level with a green line.

Using a Stochastic Oscillator When Trading S&P 500 and U.S. Dollar

Bull and Bear Set-Ups, identified by George Lane, are another form of divergence used to predict market tops or bottoms. A bull set-up forms when the security creates a lower high, but the Stochastic Oscillator forms a higher high. In contrast, a bear set-up happens when the security forms a higher low, but the Stochastic Oscillator forms a lower low. Stochastics is a favorite technical indicator because of the accuracy of its findings. It is easily perceived both by seasoned veterans and new technicians, and it tends to help all investors make good entry and exit decisions on their holdings.

The stochastic oscillator compares the current close price to the highest and lowest values over a particular period. Therefore, RSI is believed to be more effective in a trending market, while the stochastic is commonly used in a range-bound market. As with most other technical analysis tools, the stochastic oscillator, too, comes with its own set of unique advantages and disadvantages. Therefore, it’s essential to understand where this momentum indicator excels and where it fails to get the most out of its use. Rather than measuring price or volume, the stochastic oscillator compares the most recent closing price to the high-low range of the price across a fixed amount of past periods. The indicator’s goal is to predict price reversal points by comparing the closing price to previous price movements.

Is the stochastic indicator a leading indicator?

If price volatility is high, an exponential moving average of the %D indicator may be taken, which tends to smooth out rapid fluctuations in price. According to George Lane, the Stochastics indicator is to be used with cycles, Elliott Wave Theory and Fibonacci retracement for timing. In low margin, calendar futures spreads, one might use Wilders parabolic as a trailing stop after a stochastics entry. A centerpiece of his teaching is the divergence and convergence of trendlines drawn on stochastics, as diverging/converging to trendlines drawn on price cycles. If you have data on the closing prices of a security, you can import that into Excel in order to compute %K. In particular, you would subtract the highest high observed in your lookback period from the last closing price and put this into the numerator of a fraction.