The stochastic or stochastic oscillator, also called "stoch" in short, is an
indicator that tells when it is the right time to buy and sell a
cryptocurrency. This indicator is a godsend for day traders as well as those
looking for the best time to buy or sell a cryptocurrency. The stochastic
oscillator indicator was first created by George C. Lane in 1950.
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 cryptotrading 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.
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 keep coming.