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What is a Stochastic Oscillator?

The stochastic oscillator is an indicator which assists in sorting out when the price of an asset is with reference tochange direction. It indicates if an asset is overbought or oversold.

The Asset overbought is expected for a reversal(rounded-top) to the downside and the asset oversold is expected for a reversal to the upside. This assists in Exit before the trend changes and entry as the new trend begins.

The stochastic oscillator comprises of two moving average lines. It moves in and out of three distinct zones on a chart.

1.Zone at the top

2. Neutral zone in the centre

3.Oversold zone at the bottom.

The standard settings:

The overbought zone happens between the 80 and 100 levels.The oversold zone happens between the 0 and 20 levels.

The figure below portrays how the stochastic oscillatorbecomes visible in a chart when applied to price action


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No.1 indicates : The lines are in the overbought zone and the price is likely to reverse down.

No.2 indicates : The lines are in the oversold zone and the price is likely to reverse up

No.3 indicates : Neutral zone

Extreme levels indicated by the stochastic oscillator:

When the moving average lines are in the 80 zone, the asset is likely for a reversal to the downside.

When the moving average lines are in the 20 zone, the asset could be expected for a reversal to the upside.

When does it indicate Oversold?

When the excessive selling pressure forces an asset’s price unreasonably low, the asset moves average lines are in the oversold zone. This movement signalsan assets direction could change from downwards to upwards. Buy opportunity is expected at this point.


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No.1 indicates: The moving average lines have crossed below the 20 line in the figure above.

No.2 indicates: It is a likely buy opportunity while the moving average(types-moving-average) lines cross over above the 20 line.

When does it indicate Overbought?

When the excessive buying pressure has forced an asset’s price unreasonably high, the asset moves average lines in the overbought zone. This movement would indicate that an assets direction is likely to change from upwards to downwards. Sell opportunity is expected at this point. An asset's moving average line crossing in this 80 zone would consequently indicate a shift to a downward trend for the asset.

The crude oil daily chart below illustrates that, the stochastic lines have crossed above the 80 line, signifying an overbought or bearish signal.


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No.1:Once if the moving average lines have crossed above the 80 lines

No.2:which is a Potential sell opportunity when the lines cross the 80 lines to the downside.

The crossing of the lines gives a signal

What is a signal line ?Itreacts to the price changes faster than the other. This faster line tends to give earlier warnings of an asset becoming overbought or oversold.

The following can be checked with the help of the stochastic oscillator:

Whichevermoving average lines dips below 20 and then rise back above 20,abullish signal is given with prices likely to rise. Whichever line rises above 80 and then dips below 80, a bearish signal with prices likely to fall.

Changing the settings of the stochastic indicator in Enrich Market hunt:

Whenever changing the parameters of the stochastic oscillator, it is necessary that we have to monitor that whether the changes are actually improving or worsening our trading results.

Stochastic oscillator setting for Enrich market hunt software

%K Periods 9

%K Slowing 3

% D periods 9

Moving Average type:Simple moving AverageThe default values used while commencing a stochastic indicator is a cross over moving average. The above-mentioned values are best suited for Intraday trading. If you want to change or carry out the back-testing process, then it’s advisable to go through all the parameters and set up based on your own strategy with the help of Simple, exponential, Time series Forecast, triangular, variableweighted.

In the illustration chart below, the Simple moving average strategy has a setting of (%K 9, %K3, %D9),we can notice the price Buy or selling level which will be changed accordingto overbought and over sold indication.


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Summary

The stochastic oscillator is an indicator which assists in sorting out when the price of an asset is with reference tochange direction.

It indicates if an asset is overbought or oversold.

The Asset overbought is expected for a reversal to the downside and the asset oversold is expected for a reversal to the upside.

This assists in Exit before the trend changes and entry as the new trend begins.

The overbought zone happens between the 80 and 100 levels.The oversold zone happens between the 0 and 20 levels.

When the moving average lines are in the 80 zone, the asset is likely for a reversal to the downside.

When the moving average lines are in the 20 zone, the asset could be expected for a reversal to the upside.

When theexcessive selling pressure forces an asset’s price unreasonably low, the asset moves average lines are in the oversold zone.

When the excessive buying pressure has forced an asset’s price unreasonably high, the asset moves average lines in the overbought zone.

The Simple moving average strategy has a setting of (%K 9, %K3, %D9), IN TheMarket Hunt software where we can notice the price Buy or selling level which will be changed according to overbought and over sold indication.

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