The stochastic oscillator is a popularmomentum indicator. It compares the price range over a given time period to the closing price of the period.It is highly sensitive to price movements in the market and perhaps oscillates more frequently up and down than nearly any other momentum indicator.
Combining the stochastic oscillator with other technical indicators can help you confirm the signals you receive. Some of the best technical indicators to pair with stochastic are moving average crossovers, moving average convergence divergence (MACD), and relative strength index (RSI).
Key Takeaways
- The stochastic oscillator is a technical indicator that helps identify overbought and oversold signals.
- As a momentum oscillator, it pairs well with other momentum oscillators to confirm its indication.
- Some of the best technical indicators to pair with the stochastic oscillator are relative strength index (RSI), moving average crossovers, and moving average convergence divergence (MACD).
Why the Stochastic Oscillator Is Sensitive to Price
The basic theory behind the stochastic oscillator is that prices generally close near the high in an up-trending market, while in a down-trending market prices typically close near the low.
Trading signals are given when the %K line (current price compared to recent price range) crosses over a three-period moving average line known as the %D.
The stochastic oscillator is one of several momentum oscillator indicators, which also include RSI, MACD, and the triple exponential moving average (TRIX). It's used to determine price momentum as well as the strength of a prevailing trend; it can help you see reversals and retracements in trending markets. In ranging markets, the stochastic oscillator can indicate fading strength.
The stochastic's sensitivity to price movement can provide early signals of directional change in a market, but it can also provide a lot of false signals. This sensitivity can be reduced by altering the time period used; "fast" stochastic typically uses a 14-period (usually days) time frame. "Slow" stochastic uses a moving average (usually three periods) of the stochastic oscillator’s value.
Technical Indicators to Pair With the Stochastic Oscillator
Some of the best technical indicators to complement the stochastic oscillator are moving average crossovers and other momentum oscillators.
Moving average crossovers can be used as a complementto crossover trading signals given by the stochastic oscillator. A bullish crossover, which occurs when a short-term moving average crosses from below to above a long-term moving average, confirms an upward trend. A bearish crossover provides additional confirmation of a downtrend indication.
Other momentum indicators, such as the relative strength index (RSI) or the moving average convergence divergence (MACD), can also be used to complement the stochastic oscillator. Either of these commonly used momentum indicators can be looked at for signals that are in agreement with the stochastic oscillator toconfirm its indication.
What Is the Best Time Frame for Stochastic Oscillator?
You can adjust the time frame for the stochastic oscillator to one that suits you. The standard setting is 14 periods (i.e. days or hours).
How Do I Combine MACD and Stochastic?
Combining MACD and stochastic is a double-cross strategy that puts these indicators' complementary natures to good use. If you find a bullish MACD crossover that crosses slightly after the stochastic, for instance, you may confirm a trend in rising prices.
Can I Use RSI and Stochastic Together?
Yes, you can absolutely use RSI and stochastic together; some people call this StochRSI. This combo was developed by Tushard Chande and Stanley Kroll, and it shows where the RSI's current value is as compared to the high/low range for a specified period.
When you combine RSI and stochastic, you can uncover buy and sell signals that you might miss otherwise. Stochastic RSI readings range between 0 and 1, with readings below 0.2 indicating oversold and above 0.8 indicating overbought. Overbought readings in a downtrend could indicate a potential price move, for example. When using stochastic RSI, you'll want to look for crossovers to inform a buy or sell signal—when it moves from below 0.2 to above 0.2, or above 0.8 to below 0.8. But before you commit to the trade, you'll still want to confirm the price action with other corroborating evidence.
The Bottom Line
While using momentum-based indicators should not be your sole strategy, they provide valuable insights when combined with other indicators and information. Pairing the stochastic oscillator and its ability to generate overbought and oversold signals with another technical indicator can help you uncover buy and sell signals. Some of the best indicators to add to your screens with stochastic include other momentum oscillators such as moving average crossovers, MACD, and RSI.
