The stochastic indicator is one of the core indicators used today among technical analysts. Most trading platforms offer the stochastic in the list of the tools for trading and cover the topic in the courses for traders.
The Stochastic is comprised of two lines, known as the %K line and the %D line. These oscillate between 0% and 100%. The indicator is located under the price chart and consists of a scale divided by levels and two moving averages: fast% K (blue) and slow% D (orange). The Stochastic compares the closing price with the previous trading range over a specific period. It is used by traders for trading on the stock exchange and FOREX, as well as on binary options.
More About the Stochastic
The Stochastic is a momentum indicator developed by George C. Lane (1921 – 2004). He was a securities trader, author, educator, speaker and technical analyst. He was part of a group of futures traders in Chicago who developed the stochastic oscillator. It shows the position of the most recent closing price relative to the previous high-low range. The Stochastic quantifies the position of the price quotation within the prevailing fluctuation margins.
The Stochastic is comprised of two lines, known as the %K line and the %D line. The K line is faster than the D line; the D line is the slower of the two. The trader needs to watch as the D line and the price moves into either the overbought (over the 80 line) or the oversold (under the 20 line) positions. The trader needs to consider selling when the indicator moves above the 80 levels. Conversely, the trader needs to consider buying when the indicator is below the 20 line and is starting to move up with increased volume.
The %K line is calculated from the difference between today’s closing price and the period low, divided by the difference between the period high (Highest High) and the period low (Lowest Low). The %D line represents a Simple Moving Average of the %K line, and thus reacts less sensitively than the %K line.
About Generated Signals and Settings
The indicator is usually located under the price chart and consists of a scale divided by levels and two moving averages: fast %K (blue) and slow %D (orange).
K means the number of periods in the chart. If the chart displays daily data, then %K period denotes days; in weekly charts, the period will stand for weeks, and so on.
D means the number of periods used in the Moving Average calculation.
The latter form three significant zones:
- From 0 to 20 – oversold market;
- From 20 to 80 is a flat market;
- From 80 to 100 is an overbought market.
Depending on the lines traders draw the following conclusion:
- If the lines are located in the oversold zone, it indicates a previous rapid fall in prices and a high probability of trend reversal.
- If the lines are located in the upper zone, the situation is the opposite. After rapid growth, the price may dropdown.
- The neutral zone indicates the flat market. It usually coincides with the direction of the lines.
Stochastic in the Pocket Option Terminal
The Stochastic has three parameters in the Pocket Option:
Period% K, period% D and deceleration. You also can change the color of the signal lines.
Depending on your strategies, the recommendations:
- For short-term strategies: 5; 3; 3;
- For medium and long-term strategies: 14; 5; 3.
How to Trade Options with Stochastic?
According to Dr Lane, your most reliable trades occur with divergence and when the %D is between 10 and 15 for a buy signal and between 85 and 90 for a sell signal. Dr. Lane also contends the most important signal is the divergence between %D and the contract. He explains divergence as the process where the Stochastic %D line makes a series of lower highs while the commodity makes a series of higher highs. This signals an overbought market. An oversold market exhibits a series of lower lows while the %D makes a series of higher lows.
When one of these patterns appear, you should anticipate a market signal. Initiate a market position when the %K crosses the %D from the right-hand side. A right-hand crossover is when the %D bottoms or tops and moves higher or lower and the %K crosses the %D line.
In simple words:
- Call when %K moves up, leaves the oversold zone and crosses 20.
- Put when % K moves down, leaves overbought zone and crosses 80.
Set the expiration period equal to the formation of 2-3 candles.
In conclusion, we want to reiterate that the Stochastic is a favorite technical indicator because of its accuracy. Seasoned and new traders use it to make good entry and exit decisions.
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