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Trading with the Stochastic Oscillator

An experienced trader generally uses a variety of indicators to make trading decisions. These may vary from trader to trader, generally depending on their expertise, time frame of their trades and personal preferences. Yet, there are certain key indicators that almost every trader is aware of. One such indicator is the stochastic oscillator. This is an indicator that mainly helps traders gauge the price momentum over a chosen time period. 

What does the stochastic oscillator tell a trader?

The base for this indicator is the theory that in an upward trend, the price will close near the highs and in a downtrend, the prices will close near the lows. In short, the stochastic oscillator indicates if the price is in overbought or oversold territory. Typically, this indicator is range bound between 0 and 100. By rule of thumb, anything above 80 is considered overbought and anything below 20 is considered oversold.

Formula

%K = (C-L14)

          ——— x 100

          (H14-L14)

C = Most Recent Close Price

L14 = Lowest traded price of the last 14 trading sessions

H14 = Highest traded price of the last 14 trading sessions

%K = Current value of the stochastic oscillator indicator

Explanation: Generally, a 14 day period is considered as the time frame, but this can be adjusted according to a trader’s outlook. The stochastic oscillator is typically read by using 2 lines. One is the value of the stochastic indicator (%K) and the other is a 3 day simple moving average (%D). The moving average periods can also vary, depending on the trader’s preferred time duration. Traders look for moments when %K intersects or crosses %D, providing them with trade signals. 

Is the stochastic oscillator always right?

Experienced traders would know that depending on just one single indicator is not advisable. Any indicator, including the stochastic oscillator, should be used simultaneously with other trusted indicators and a view of fundamentals in order to trade prudently. This is because an indicator can prove to be inaccurate when used alone. 

For example: Company XYZ has announced massive profits in its quarterly earnings report. The stochastic oscillator prior to this news showed that the company’s stock was overbought. This indicates a sell call to a trader using the indicator, but shockingly, the price continues to rise after the sale. The trader here ignored fundamental news which caused an upward trend and they missed out on profits. Although this example is simplistic, it shows that stand-alone indicators can prove to be wrong. 

Conclusion

The world of trading can be an intimidating place and can easily burn a hole in your wallet if you do not understand what you are getting into. It is advisable to educate yourself before putting your money into play. It is also important to have your long term investments, insurances, emergency funds, etc. in place to ensure your financial security. 

If you have a surplus after this is taken care of, only then should you consider trading, as it can be unpredictable. If you wish to begin trading, download the MO Trader App to get started. If you are new to the world of investments, you can get started by learning about the market and opening your demat account online.

Related Articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | Factors to Consider When Opening a Demat Account | 10 Points to Remember When Operating your Demat Account | Types Of Demat Account & Trading Account | Upcoming IPO | LIC IPO

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