I just tried to understand the Stochastic Oscillator more deeply because although many people use it for trading, if you ask what the stochastic really is and how to calculate it, sometimes it can be confusing.

Simply put, the stochastic is an indicator that shows where the current closing price is within the highest and lowest prices over the past 14 days. It ranges from 0 to 100 only. Imagine easily that if the price keeps rising, the closing price will be close to the high of the period, making the stochastic value approach 100. Conversely, if the price keeps falling, the closing price will be near the low, and the value will approach 0.

It consists of two lines: %K, which shows the actual value, and %D, which is the moving average of %K, usually over 3 days. The main use of the stochastic is to indicate whether the price is overbought when above 80 or oversold when below 20.

What’s interesting is that it can also help identify trends. If %K is above %D, it indicates an upward trend. If %K is below %D, it indicates a downward trend. The gap between the two lines shows the strength of the trend; the wider the gap, the stronger the trend.

Another common method is to look for divergence points, such as when the price keeps rising but the stochastic value keeps falling. This signals that the bullish trend may be ending.

Its advantage is that it’s easy to use, simple to calculate, and easy to understand. However, its downside is that it’s a lagging indicator and can generate false signals often if used alone. Therefore, combining it with other indicators like EMA, RSI, MACD, or analyzing price patterns can make the signals more accurate.

For settings, most people use the default 14 periods, but some adjust based on their trading timeframe. For example, if trading on 5-minute charts, they might use different values. It’s better to experiment and find the setting that suits your trading style.