That's why we look for a point to open a short trade in overbought zones. Thus, if we analyze the overbought and oversold levels of the EURUSD chart, we can spot a bearish trend. Combining a stochastic indicator with other trading tools can help the user to spot easier overbought and oversold conditions. If there is an upward trend, place long trades. For instance, if a downtrend prevails, open only short positions. In the simplest stochastic oscillator strategy, signals are filtered by the trend direction. Nevertheless, it's not recommended to trade using only the stochastic oscillator as a momentum indicator. If it is in the oversold area, you should open a long trade to avoid losing money rapidly. If it happens in the overbought zone, it’s a signal of a short position. This is how the user can easily spot the overbought and oversold levels of the market. When they fall below the bottom horizontal line of 20% (red zones in the bottom), it's oversold. When two lines are above the upper level of 80% (marked with blue zones at the top), the instrument is overbought. The solid orange line in the image above is called %K, and the blue line is the 3-period moving average of the %K curve. It can be found under the name "%R Larry Williams Oscillator" or simply "R Williams." How Does the Stochastic Oscillator Work?Ĭlassically, a stochastic oscillator as a technical analysis tool is represented by two moving curves that move between two levels. This is how the well-known stochastic oscillator was created.Īt the same time, the stochastic %R did not disappear. However, it is called stochastic and even has a % symbol. Technically, D isn't stochastic - it is a derivative from %K. However, only two options, %К and %R, were successful.Ī combination of the stochastic indicator %К and its moving average, named D (from the word deviation), became the best option that can spot when the asset is overbought or oversold. Each formula was named by sequential letters of the Latin alphabet: %A, %B, %C, etc. Combinations of price bar parameters and their derivatives were sorted out to determine the best stochastic oscillator formula. The stochastic indicator was based on the price bar's major parameters – closing, high, and low prices.Īccording to one of the theories, there were initially different types of the stochastic oscillator formula. So, he developed an indicator that would catch these dynamics and signal reversals in both directions. Once, while observing the price changes, he noticed that there was not a trend but a reciprocating movement that prevailed on the market. The stochastic oscillator indicator was invented in 1950 by American stock analyst George Lane. The stochastic oscillator formula is considered effective when it is used on a 1-minute timeframe as well as on hourly, daily, or weekly timeframes. The premise of a stochastic oscillator is that the closing price stays at the previous local maximums for a while in the bullish trend and stops at the level of prior minimums in a bearish trend. The instrument's primary function is to determine market patterns, such as: The stochastic oscillator is a technical analysis indicator that reflects the dynamic changes between the bar's current closing price and price extremes for a given period.
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