What is the stochastic indicator?
The stochastic indicator is a momentum indicator and follows the speed of price movement. It is made of two moving averages, known as K and D, which measures the close relative to the high- low range over chosen periods. Like many momentum oscillators it can be used to indicate overbought or oversold conditions, generally under 20 being oversold and over 80 being overbought.
How is it calculated?
%K = 100(C-L14)/(H14-L14)
%K = The current market rate
C = Recent closing price
L14 = The low of the previous 14 periods
H14 = The highest of the previous 14 periods
%D = 3-period moving average of %K
How to trade stochastic
It is believed that when the market is in an uptrend the price will close at the 14 period average close which is shown by the stochastic showing above 80 and when in a downtrend it is believed that the price will close at the average of the previous 14 period low which id shown as being under 20. This means the stochastic can be traded by buying when the stochastic is under 20 and selling when above 80, but for more confluence it is best to wait for the 3day moving average to cross the K line indicating a potential reversal.