The stochastic oscillator is a popular tool for determining the overall direction of a market. It is represented by two indicators called %K and %D. It is a “Banded oscillator” meaning that it fluctuates between 0 and 100. It tends to do well in a sideways market. Conversely MACD tends to do well in trending markets.
Overbought and Oversold
In the following video Jeffrey gives a good explanation of the terms “overbought” and “oversold”. He says these two terms are responsible for more lost money among rookie traders than anything else. Typically any stochastic reading over 80 is considered to be “overbought” while anything under 20 is considered to be “oversold”. But that doesn’t mean what you think it means!
Divergence
Stochastic is a good tool to identify divergences. Divergence helps to identify a “pause” in the market but doesn’t always indicate a change in direction or a long-term “top” or “bottom” in the market.
Another way to use Stochastic is as a trend analysis tool. If the short term trend is up the indicator should remain above 50. If the indicator is above 80 you have a strong trend up. On the other hand if it is below 50 the short trend is down and if it is below 20 it is in a strong down trend.
Cross-overs
Stochastic cross-overs of the 50 line can be used to determine buy and sell points as well.
So watch the video and get some great tips on using stochastics in your trading. ~ Tim McMahon, editor
A lesson from EWI’s Jeffrey Kennedy
By Elliott Wave International
The stochastic oscillator is a technical tool that was popularized by George Lane. It is a momentum indicator based on the idea that in an uptrending market the close tends to be near the high of the price bar, and in a downtrending market the close tends to be near the low of the price bar.
Watch an 11-minute lesson from Jeffrey Kennedy’s Trader’s Classroom to learn how you can use this popular indicator in your analysis and trading.
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In these three video lessons, Jeffrey Kennedy shows you how to look for trading opportunities in your charts. Kennedy, instructor for Elliott Wave International’s popular Trader’s Classroom service, reviews the 5 core Elliott wave patterns and then shows you how to combine technical methods to create a compelling forecast.
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This article was syndicated by Elliott Wave International and was originally published under the headline How to Use the Stochastic Oscillator. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.
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