The Stochastic Oscillator is a popular momentum indicator used to assess the strength and potential reversals of a price trend by comparing the closing price of an asset to its price range over a specified period.
It consists of two lines: the %K line and the %D line.
%K Line: current closing price about the price range over a specific period
%D Line: moving average of the %K Line helps smooth out its fluctuations and provides additional insights
Both %K and %D Lines "oscillate" between 0 and 100.
How the Stochastic Oscillator is calculated
Golden Cross and Death Cross
When the %K line crosses above the %D line (Golden cross), it generates a bullish signal, suggesting that the asset may experience upward price movement. Conversely, when the %K line crosses below the %D line (Death cross), it generates a bearish signal, indicating a potential downward price movement.
%K and %D lines combined could produce signals
Overbought and Oversold
A stochastic Oscillator reading above 80 is considered overbought and below 20 is considered oversold.
However, it is important to note that the stochastic reading in the oversold region does not mean a "buy signal."
Instead, it is still considered bullish while in the overbought level and bearish while in the oversold level.
The trend is expected to end (weaken) and potentially reverse (turning point) when the stochastic oscillator breaks above/below the overbought/oversold level.
Oversold DOES NOT Mean "BUY"
Indicators may move in a reverse direction of the price trend: "Divergence." The divergence of oscillators suggests that the trend may reverse soon. However, as always, confirmation is crucial; you cannot solely enter the trade depending on divergence but should confirm with price action and other indicators.
Divergence could be helpful finding trend reversals
Overall, the Stochastic Oscillator provides traders with insights into the momentum and potential turning points of an asset, helping them make informed trading decisions.