Stochastics Indicator Formula, Settings, Strategy

Stochastics Indicator

Stochastics Indicator or also known as the Stochastics oscillator is a momentum indicator. It shows the location of the close relative to the high-low range over a set number of periods. In the late 1950s, George C. Lane developed this indicator. This indicator follows the speed or the momentum of price and the momentum changes direction before price. This was Lane’s first and most important identified signal. The developer George C. Traders can use this oscillator to identify bull and bear set-ups and to anticipate a future reversal. This technical indicator is useful for identifying overbought and oversold levels.

The stochastic oscillator is a highly popular technical indicator that is used by traders all over the world. The stochastics is actually an oscillator, i.e, it oscillates between 2 values. Stochastics Oscillator oscillates between the value of 0 and 100.

The traders can know more about Stochastics in their terminal. They can find it in the STUDIES section of Zerodha Kite and it also available in Kite mobile App. The Period is 14 and you can set the value of it high and low. You can also check the image below to understand how to attach the Stochastics indicator in HDFC Bank share price chart. In this indicator on to any charts likes daily, weekly, monthly or intraday you can attach.

Stochastics Indicator Settings

Calculation of Stochastics Indicator:

We measure the Stochastics with the %K line and the %D line, and it is the %D line that we follow closely, for it will indicate any major signals in the chart.

%K = (C-L5close)/(H5-L5) * 100
%D = 3-day SMA of %K.

where,
C = the most recent closing price.
L5 = the low of the five previous trading sessions.
H5 = the highest price recorded within the same 5-day period.

Stochastic Oscillator
Stochastics Indicator in AmiBroker

Usage of Stochastics Indicator:

  • The major usage of Stochastics Indicator is to identify the overbought and oversold condition of the market.
  • Most traders use this indicator on the basis of crossover of %D and %K.
  • %D crossing above %K is considered as buy signal and %D crossing below %K is considered as a sell signal.
  • Few traders also use this indicator on the basis of divergence signals.

The traders consider a stochastics value of close to 0 as oversold, i.e, market is enough sold and can bounce back any time. Whereas they consider the stochastics value of close to 100 as overbought, i.e, the market is enough bought and can take a correction any time.

Two stochastic oscillator has 2 lines (%ok) and (%d). The 2 lines cross each other and we consider this as the buy/sell signal. We call the %k line crossing the %d line above as the buy signal. Whereas we call the %k crossing the %d line below as the sell signal.

There are multiple ways to trade the stochastics. Some traders trade on the basis of overbought/oversold. The other school of thought is stochastics can remain in the overbought or oversold region for a long time. So some traders enter long in the overbought value of stochastic oscillator while they short sell on the oversold.

Some traders trade on the basis of %d and %k line crossover alone. But this is not a very reliable method of trading. Another way of trading stochastics is to trade the divergence, i.e, when the price and stochastics diverge (suppose price makes higher high but stochastics makes lower high. This denotes that the price can reverse back soon.

Conclusions:

Stochastics is a favorite indicator of some technical analysts because of the simplicity of its usage and also the accuracy of its readings. This indicator is easy to perceived by seasoned veterans and new technicians both. It tends to help all investors make a good entry and exit decisions on their holdings. We can also use this indicator to identify turns near support or resistance.

Author: Ankita Chakraborty

Ankita has done her Diploma Engineering in Computer Science & Technology. She is pursuing her degree in Engineering and also well experienced in the equity market and real estate related content writing. She is the one who has developed the technical indicators section of our site.

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