The stochastic indicator is a momentum indicator. The stochastic indicator is developed by George C. Lane in the 1950s.
The stochastic indicator is calculated using the following formula:-
- %K = (Most Recent Closing Price – Lowest Low) / (Highest High – Lowest Low) × 100
- Lowest Low = lowest low of the specified time period
- Highest High = highest high of the specified time period
- ( %K = Indicators, %D = Signal Line)
- The formula is very important to understand the reason behind any indicators.
- The default setting for the stochastic indicator is 14 periods and you can use it in any timeframe; such as daily, weekly, or even intraday.
Let us understand how you can use a stochastic indicator in trading.
- To identify the overbought or oversold conditions.
- You can identify overbought or oversold conditions of stock or market by the stochastic indicator.
- You can check in the below image of AXISBANK APRIL 2020 Chart that how stochastic indicator we can use to identify the oversold position of axis bank and stock also bounce back from that level.
- You can check in the below image of AXISBANK APRIL 2020 Chart that how stochastic indicator we can use to identify the overbought position of axis bank and stock also started downtrend from that level.
2. Bullish and Bearish divergences
Divergence means when an indicator and the price of an asset are heading in opposite directions.
There are two types of divergences:-
- Negative Divergences:-Negative divergence happens when the price of a security is in an uptrend but an indicator starts downtrend.
- Positive Divergences:- Positive divergence occurs when the price is in a downtrend but an indicator starts uptrend.
—+ So divergences can be used as a reversal tool by confirming with other tools and indicators.
Conclusion:- So you can use stochastic indicator in trading to identify overbought/oversold conditions or divergences with other tools and indicators.
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Note: All the above information is just for educational purpose only.