Stochastic oscillator

Share this content

The stochastic oscillator is a popular technical analysis indicator that can be used to produce efficient and profitable trading signals. In this article, we’ll let you know how to calculate it, how to use it for trading cryptocurrencies and how to combine it with other technical analysis indicators to generate more profitable trading signals.

What is the stochastic oscillator?

The stochastic oscillator is a momentum indicator that measures the rate of change of price. It is used to identify overbought and oversold conditions in the market, as well as to generate buy and sell signals. The stochastic oscillator can be used on any time frame, but it is most commonly used on daily or weekly charts. It is made up of two lines, %K and %D, that fluctuate between 0 and 100. %K is the main line and is a measure of the current price compared to the previous closing prices. %D is the signal line which is usually a 3-period Simple Moving Average of %K.

Stochastic oscillator on Binance BTC/BUSD market.
On this picture, the stochastic oscillator is below the candlestick chart. The %K line is in blue and the %D line is in yellow. You can see that the %D line trails behing the %K line.

How to calculate the stochastic oscillator?

The stochastic oscillator is calculated using the following formulas:

%K = 100(C – Ln)/(Hn – Ln)

Then, the %D line is a z-period (usually 3) Simple Moving Average of %K.

Where:

  • C = the closing price of the security
  • Ln = the low price of the security over the past n periods (usually 14)
  • Hn = the high price of the security over the past n periods (usually 14)

A smoothing period is sometimes applied to %K, prior to the calculation of %D. This means computing a Simple Moving Average of %K before calculating %D.

What trading signals does the Stochastic oscillator give?

The stochastic oscillator can be used to trade any cryptocurrency, but it works best on those with high liquidity and large trading volumes.

The stochastic oscillator can generate the following signals:

  • Overbought signal: when the stochastic oscillator is above 80, it is considered to be overbought and a sell signal is generated.
  • Oversold signal: when the stochastic oscillator is below 20, it is considered to be oversold and a buy signal is generated.
  • Divergence: when the price of the security diverges from the stochastic oscillator, it is a sign that the current trend is about to reverse.
  • Bullish and bearish cross: whenever the %K line crosses the %D line from below in the low-range values, it can be interpreted as a buy signal. Conversely, when the %K line crosses the %D line from above in the high-range values, it can be interpreted as a sell signal.
Oversorld and bearish cross signals from the stochastic oscillator.

The picture above is drawn from Binance’s BTC/BUSD spot market. Both the %K line and the %D line are below 20 on the left circle, giving an oversold signal. Then, the %K line crosses below the %D line, giving a bearish cross signal.

What other indicators can be used with the stochastic oscillator?

The stochastic oscillator can be used with other technical indicators to generate more accurate trading signals. Some of the most popular indicators to use with stochastic are the moving average convergence divergence (MACD) and the relative strength index (RSI). These indicators can help confirm stochastic signals and provide additional information about market conditions. Traders also often use the stochastic oscillator in conjunction with support and resistance levels, to generate more accurate trading signals.

How to use the stochastic oscillator with MACD

The stochastic oscillator can also be used in conjunction with the MACD to generate more accurate trading signals. The MACD is a trend-following indicator that measures the difference between two moving averages. It is used to identify the direction of the market and to generate buy and sell signals. When the stochastic oscillator is used with the MACD, it can help confirm stochastic signals and provide additional information about market conditions. For instance, if the MACD is positive and the stochastic oscillator reaches upwards of 80, it is a strong overbought signal and thus a good time to sell.

How to use the stochastic oscillator with RSI

The stochastic oscillator can be used in conjunction with the RSI to generate more accurate trading signals. The RSI is another momentum indicator that measures the speed and change of price movements. It is used to identify overbought and oversold conditions in the market, as well as to generate buy and sell signals. When the stochastic oscillator is used with the RSI, it can help confirm stochastic signals and provide additional information about market conditions. For instance, if the RSI is above 70 and the stochastic oscillator reaches upwards of 80, it is a strong overbought signal and thus a good time to sell.

How to use the stochastic oscillator with support and resistance levels

The stochastic oscillator can also be used in conjunction with support and resistance levels to generate more accurate trading signals. Support and resistance levels are price levels where the market has a tendency to reverse direction. They are used to identify potential buy and sell opportunities in the market. When the stochastic oscillator is used with support and resistance levels, it can help confirm stochastic signals and provide additional information about market conditions. For instance, if the stochastic oscillator is overbought and the price is approaching a resistance level, it may be a good time to sell.