Hello, dear friends. Forex market is the world's largest and
most liquid financial market, attracting the attention of everyone due to its
high trading volume and global reach. This market offers us the opportunity to
trade various financial instruments (various currency pairs, commodities, stocks,
and indices). However, in order to be successful in this vast financial arena,
we need to have vital knowledge of trading psychology, risk management methods,
technical and fundamental analysis. When it comes to trading in financial
markets, technical analysis is the most preferred method. The basic logic of
technical analysis is to examine past price movements to predict future price
movements, based on the belief that past price data can affect future prices.
There are many tools and indicators used in these predictions, and one of these
tools is the Stochastic Oscillator. Therefore, the subject of our article is
the Stochastic Oscillator, which is a simple technical indicator that is easy
to use and interpret.
What is the Stochastic Oscillator?
The creator of the Stochastic Oscillator is George C.
Lane. Lane developed this indicator in the 1950s, and it has become a
widely used technical indicator in financial analysis. The Stochastic
Oscillator is used to identify overbought and oversold conditions and measure
market momentum. For this reason, George C. Lane is regarded as the Father
of the Stochastic Oscillator. The Stochastic Oscillator is based on
comparing the closing prices within a specific period to the current price. It usually
represents a value between 0 and 100 and indicates where the current price of a
financial instrument is in relation to the lowest and highest price range
within a certain period. The basic principle of the Stochastic Oscillator is to
determine overbought and oversold conditions by measuring the volatility and
speed of price movements within a specific period. Generally, when the %K
component of the Stochastic Oscillator is above 80, it is considered overbought
conditions, and when it is below 20, it is considered oversold conditions,
while the %D component is used to confirm this signal. When used in conjunction
with other technical analysis tools such as moving averages, trendlines, and
support and resistance levels, the Stochastic Oscillator can contribute to
identifying more precise entry and exit points.
The Main Components and Calculation of the Stochastic
Oscillator
The Stochastic Oscillator is a frequently used tool for
tracking price movements and understanding market momentum. The default period
used in the calculation of the Stochastic Oscillator is typically set to 14.
The main components of the Stochastic Oscillator are as follows:
1. %K Value (Blue Line). This represents where the
closing price within a specific period is in relation to the highest and lowest
price range within the same period. This value is typically a number between 0
and 100. To calculate the %K component of the Stochastic Oscillator, the
formula is as follows:
%K = [(C - L) / (H - L)] * 100
Here, H represents the highest price within a specific period (usually 14), L represents the lowest price, and C represents the closing price within that period.
2. %D Value (Orange Line). %D is the moving average
of %K. It creates a smoother curve and is easier to interpret compared to %K.
After obtaining %K values, a period is chosen to calculate the moving average
of %K values. To calculate this moving average, the %K values within a specific
period are summed up and divided by the number of periods. The formula used to
calculate the D% value is as follows:
D% = (K% + K% + K% + … n) / n
Here, n represents the number of periods. This is how
the %D value is obtained. %D is a kind of average of %K and represents a
smoother version of the Stochastic Oscillator. These values are usually shown
as lines on a chart and provide us with the opportunity to monitor overbought
and oversold conditions as well as market momentum. When trading in the market
we don't need to perform these complex calculations ourselves, the oscillator
does it automatically and presents it to us in line form. The colors mentioned
above are defaults and can be customized through indicator settings.
How to Use the Stochastic Oscillator in Trading?
The Stochastic Oscillator is a commonly used technical
indicator in technical analysis, and it helps identify overbought or oversold
zones of a financial instrument. A value above 80 indicates overbought
conditions, while a value below 20 indicates oversold conditions. Similar to
other technical indicators (e.g., the RSI indicator), with the Stochastic
Oscillator, when the oscillator value is in the overbought zone, it is believed
that prices will fall, and a sell order is placed. Conversely, in the oversold
zone, a buy order is placed. If the Stochastic Oscillator is above 80 and the
%K (Blue Line) crosses below the %D (Orange Line) from above, it's a signal to
enter a Sell order. Conversely, if it's below 20 and the %K crosses above
the %D from below, it's a signal to enter a Buy order. This approach is
considered one of the most reliable among Stochastic Oscillator strategies and
tends to work better in ranging or sideways markets.
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| Stochastic Oscillator in EUR/NZD chart |
Stochastic Indicator can also be used to identify
divergences between the price chart and the oscillator. Additionally, price and
indicator divergences in the Stochastic Oscillator can be used to detect and
confirm trend reversals. You can find more detailed information on how to trade
using divergences and their types in the article Divergences.
Note that. Although we can take advantage of many
benefits when trading in the Forex market using the Stochastic Oscillator, we
may also encounter its disadvantages at times. Like all indicators, the
Stochastic Oscillator can produce false signals. Therefore, no single technical
indicator is sufficient on its own. While the promise of high returns may make
financial markets appear attractive, there is always a risk of capital loss
during trading. Please do not engage in high-volume trading solely relying on a
single indicator. It's important to always use multiple indicators in
conjunction with each other and give importance to fundamental analysis.♥Happy
trading !