Stochastic Indicator: what is it and how does it work?
It may sound complicated, but the Stochastic Oscillator (another oscillator obviously!) is a technical analysis tool that can actually be simple to use. While it has many uses, many traders use it to spot when a trend is about to end, making it perfect for timing entries and exits.
How does it work?
The Stochastic compares the closing price of a market with a range of prices from that market over a previous period (usually the last 14 days).
You don’t need to know how to work out the Stochastic yourself to use it, but if you’re interested, here’s how it’s calculated:
- Decide what period you’re going to use to calculate the Stochastic. This is usually 14 days but you can choose your own period if you prefer.
- Find the lowest low price and the highest high price from the period you’re using.
- Calculate the difference between the current closing price and the lowest low price.
- Now work out the difference between the lowest low price and the highest high price.
- Divide the difference between the current closing price and the lowest low price by the difference between the highest high price and the lowest low price.
- Multiply your answer by 100 to give yourself a percentage.
How to trade with the Stochastic
As we said, you don’t have to calculate the Stochastic to use it to trade. In fact, once you’ve added it to your trading platform (see the steps below for more info) using the Stochastic to time your trades couldn’t be much easier…
When the Stochastic rises above 80% it’s a sign that the market is overbought. That means that the market has overheated and the price could be about to drop.
On the flipside, if the Stochastic drops below 20% it’s an indication that the market is oversold. That means that the selling pressure is about to ease off and the price could start to rise.
Of course, the Stochastic is only an indicator. While it may help you make a buy or sell decision you shouldn’t rely on it 100%. You should always use a mix of indicators, experience and analysis when making a trade.
How to add Stochastic to Skilling
Adding Stochastic to your Skilling trading platform is simple:
- Type Stochastic into the indicator dropdown menu and select Stochastic.
- The settings screen for the Stochastic is now displayed.
- You can use the default input data or enter your own.
- Click the OK button to add the Stochastic to your trading platform.
Stochastics is another oscillator and also a popular choice among many technical analysts. Like a few others it uses overbought and oversold levels of 80 and 20. Be sure to use it with other indicators though to avoid trading on too many false signals - this will help your risk management too.