It is a mathematically based indicator, which is why people did not like it much, but as technology progressed, it was made more simple, which has now made it the most popular tool among traders. Especially for day traders. This tool was earlier used in stock trading, but now it is being used in crypto trading as well.
Today's guide will be on the stochastic oscillator indicator, what it is, and how it works so that you can make maximum profits. Since this is an advanced crypto trading tool, it will hardly be in your normal wallet or exchange charts, but if you are using Tradingview or your exchange is supporting Tradingview charts, then you can enable it.
What is a stochastic oscillator?
The stochastic oscillator is an indicator that displays the buy and sell movement of a coin over a given period of time. According to an interview with Lane, the stochastic oscillator "doesn't follow price, it doesn't follow volume or anything like that. It follows the speed or momentum of the price.
Speaking directly, it only tells at what time the traders are buying (overbuying) the coin and at what time they are selling it (overselling). It has nothing to do with bull or bear markets. But it is capable of telling whether the market is bullish or bearish.
Structure of a stochastic oscillator.
The stochastic oscillator is simply two lines that indicate buy and sell momentum breaks over a given period of time. One line is called %K, and the other is called %D. If everything is normal, then its the up-and-down pattern will be exactly like the price chart.
It does not have a fixed colour like the price chart (red or green); you can set it to whatever colour you want.
It is shown as a percentage, which ranges from 0% to 100%, while the threshold level is 80% for overbought and 20% for oversold.
From these two lines, one (%K) reflects the actual value of the oscillator for each session, and one (%D) reflects its three-day simple moving average. In which K is faster while D is slower, and the trader needs to focus on indicating the D line.
It consists of the following components:
%K line: This is the main line of the oscillator, and it is calculated as the current closing price of the security divided by the highest high and lowest low of the security over a specified number of periods.
%D line: This is a moving average of the %K line, and it is used as a signal line to generate buy or sell signals.
Overbought and oversold levels: These are predetermined levels, typically set at 80 and 20, that indicate when security may be overbought (priced too high) or oversold (priced too low).
Crossovers: A buy signal is generated when the %K line crosses above the %D line, and a sell signal is generated when the %K line crosses below the %D line.
Understanding the stochastic oscillator indicator.
As I mentioned earlier, out of the two lines, you have to focus on the D line indicator, as it tells the moving average, which shows when to buy and sell any crypto. 20% or less is a good time to buy a crypto using the stoch indicator, but 80% is a good point if you want to sell a crypto.
When the price is high, the stochastic is also high, and buying any type of cryptocurrency at this point is very risky because this is the same peak point from which traders can start selling their bought crypto. Similarly, when the crypto price is low, the stochastic indicator also goes down, which is the right time to buy any cryptocurrency.
This indicator shows the buying and selling momentum of a certain time frame, and it is not necessary that this momentum will continue in the next time frame as well. For example, in a time break (say, an hour time break), the price of a coin is $10, and the stoch value is 70%. At the very next time break, the stoch value falls by 15% and the price becomes $9.58. Again, in the next time break, if the stoch value increases by 70%, but it is not necessary that the price again increases to $10.
But yes, if you buy coins at a 15% stoch value, then you will definitely get some benefit if the stochastic value increases to 70%.
Looking at the below USDT/DOGE chart, you can see that when the stoch value is 73.96%, the price of DOGECOIN is $0.142. After a few days, the stoch value falls to 4.75% and the price becomes $0.075. But when the stoch value rises again to 83.41%, the price remains at $0.10 instead of $0.142. This also proves that the price does not go up when the stochastic oscillator indicator goes up.
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| The red box shows the price and the yellow box shows the stochastic oscillator indicator. |
Limitation of the stochastic oscillator.
The stochastic oscillator can generate false signals, particularly in range-bound or choppy market conditions. Additionally, if the market is highly volatile, relying solely on the stochastic oscillator indicator can be risky in that situation.
This indicator is not suitable for new cryptocurrencies because it does not have the appropriate data to compare price charts with. The stochastic oscillator indicator for the same cryptocurrency on two or more exchanges can be different, which can cause confusion. Also, a signal delay can cause huge investment losses.
Concluding.
Stochastic oscillator signals should be used in conjunction with other technical and fundamental analysis to make informed investment decisions. Additionally, it's also important to consider the market conditions and the volatility of the cryptocurrency when interpreting the signals generated by the oscillator.
In conclusion, the stochastic oscillator is a useful tool for financial traders and investors as it provides information on the momentum of a cryptocurrency's price, helping to determine if it is overbought or oversold and to generate buy and sell signals.
Note - This article is part of the "Understanding the Crypto Trading Chart" series. More articles are keep coming.
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