Stochastic Oscillator

The aim of the Stochastic Oscillator is to determine price behaviour and reversals by monitoring close prices within the recent highs and lows.

The method is based on the observation that when prices are rising their close levels tend to be closer to the top. If the prices keep rising whereas daily close levels start falling it signals that the trend is ready for the reversal.
If the quotes tend to move downwards, the close is usually near the bottom.

СThere are three stochastic lines: %K, %D, %R. They reflect current close price position against the chosen time period.

%K = 100 ( ( C — Ln ) / (Hn — Ln) )

where
C — current close price,
Ln — the lowest bottom within the number of bars of the chart
Hn — the highest top within the number of bars.
%D = SMA (%D , n1)
n1 — the value of the simple moving average.

The main signals for Stochastic:

• The indicator was created in order to trade in the flat market. Now bullish divergence / bearish convergence is the main signal that shows that the current trend is weak and reversal or correction are possible;
• In a flat market, exit from the overbought (oversold) area is a signal to sell (to buy);
• If the solid line (%K) crosses the dashed line (%D) from below this is a signal to buy; if the solid line (%K) crosses the dashed line (%D) from above this is a signal to sell.

Interaction between oscillators and price chart (hereinafter price is above and oscillator is below)

Bearish convergence:

middle signal

If the end of the oscillator is near the upper edge price fall is possible.

If the end of the oscillator is near the upper edge price fall is possible.

weak signal

We expect price stabilization with further trend change.

middle signal

If the end of the oscillator is near the upper edge trend strengthening is possible.

If the end of the oscillator is near the lower edge price rise is more possible.

If the end of the oscillator is near the mid price fall and stabilization are equally possible.

Bullish divergence:

middle signal

If the end of the oscillator is near the lower edge price rise is possible.

If the end of the oscillator is near the mid price fall is more possible.

weak signal

We expect price stabilization with further trend change

middle signal

If the end of the oscillator is near the lower edge trend strengthening is possible.

If the end of the oscillator is near the upper edge price stabilization is possible.

If the end of the oscillator is near the mid price rise and stabilization are equally possible.

Parallelism:

middle signal

Strong trend upwards

weak signal

Trend change is expected

middle signal

Strong trend downwards

Final note

When the trend is strong oscillators should be treated carefully. As a rule, false signals indicate the trend strengthening.

If the trend is upward oscillators are mainly in the overbought area and vice versa if the trend is downward oscillators are mainly in the oversold area.