When to Apply Stochastic Oscillator

 

Understanding

 

Stochastic Oscillator is one of the commonly used indicators by many traders to measure the exit and entry. However, there isn’t 1 indicator that fits all trends. If you like to use Stochastic Oscillator but are still confused about why it sometimes works but sometimes doesn’t, we will share with you the in-depth of this indicator, starting from the origin of its formula structure in this blog. 

 

Stochastic Oscillator Formula:

 

Understanding how the formula works is important. This will let us know the data that's been used for the calculation of its lines and what are the results of this calculation for. 

 

The formula of the Stochastic Oscillator is to calculate the %K line which is also known as the Fast Stochastic Line. Where the %D is derived from the 3 period MA of %K. Therefore, the main focus here is %K.

 

%K formula consists of the current closing price, the lowest price traded in the past 14 trading days, and the highest price traded in the past 14 trading days. This shows that the result of this formula is to find the traded price falls in which range of the High & low of the trading days. 

 

This means that the %K is an indication to tell us how fast the price is changing within the 14 periods of the trading day, while the High & Low of the past 14 days have not changed much. 

 

To make it easier for you to understand the formula structure, we have illustrated the below image by breaking down the formula structure for your understanding:

 

 

Based on the above illustration, %K basically measures the recent price change within the last 14 days high and low. Usually, the Highest price & Lowest price don’t change often unless it is in a trending situation (up/ downtrend), setting a new high or low daily. The recent closing price is the variable that could have huge changes within the 14 days. When the recent price changes are close to the previous 14 days high, %K would probably be around 80% or more.

 

By understanding this, we know that the %K is a measurement of how fast the price changes within the given period. This means %K is just an indication that tells us, the recent price changes are near the range of the previous 14 days' High & Low changes. 

 

Can we apply %K & %D overbought oversold as an indication for exit or entry?

 

The answer is no because %K & %D served as an alert to us that the recent price change is near to the H14 & L14 changes range. If the big boys still have the intention to push higher, then a new H14 will be formed. OR dumping their shares to a lower price, a new H14 will be formed. That’s why you will notice that %K will often stay at the oversold zone (below 20%) when it is in a downtrend. 

 

How do we apply a Stochastic Oscillator to gauge our entry & exit?

 

George Lane the developer of Stochastic Oscillator once said in an interview:

the stochastic oscillator can be used to foreshadow reversals when the indicator reveals bullish or bearish divergences. This signal is the first, and arguably the most important…

 

This means the first thing we need to look at is whether there is a short term bullish or bearish divergence in %K & %D with the price. But many traders or “Gurus” nowadays share the wrong steps or ideas, focusing only on the overbought & oversold indication. 

 

Therefore, to analyze the stock price changes or trend reversal, we need to look at it with the steps below :

 

1) Any divergence in price & %K line

2) Then act upon it when the %K line is overbought or oversold after the Divergence is formed.

 

Take Note:

 

- Do not use divergence as the final indication of the short term price reversal. Short term price reversal might come later after a divergence is shown. Therefore, treat any sign of divergence as a pre-alert to a price reversal. 

- Big boys sometimes will continue to mark up the price to distribute the remaining shares in their hands to maximize the profit, before dumping the remaining small percentage of their holding out to the market and creating a sharp price fall.

- If your input is 14 days then the measurement will only be 14 days before the recent price. The highest & lowest traded price 28 days before might be different from the recent 14 days. When you are studying the indicators for any divergence, make sure the data are in-line with the time the divergence is formed. 

- Because the formula records data of traded high & low prices, therefore, in an up-trending or down-trending stock, the High & Low of the traded price will continue to change. Which will cause more variables/ changes in the formula and not be able to define a constant range of High & Low for the %K to measure overbought or oversold. That’s why Stochastic is better for sideways trending stocks. 

 

Limitation of Stochastic

 

The limitation of the Stochastic Oscillator is the same as many other indicators, lagging & price reacted before stochastic actually shows the signal. Which might cause the traders or investors late to exit and not able to maximize the potential profit while potential losses might incur. 

 

These flaws are very common in many indicators, it is because the indications are based on historical price changes. The developers are trying to smoothen the price movement by averaging out the price data and assuming the price will be traded in the same pattern. As we know in the current financial market, prices don't move in the same pattern with all the available trading functions in the market such as short selling, market size, & expectation of the big boys. 

 

When price & volume are being averaged out, the information from the price & volume transacted pattern are being ignored or taken out. That’s why indicators are not able to tell the intention of the big boys whether they are attracting buyers with price marked up & false buy transactions, or preparing to dump the shares out to the retail investors parking at the lower buy order. 

 

If you really want to use indicators for your trades or investments, you must study and understand how your indicators work in different trends, market size, volatility, & other factors that could affect the indicator’s formula having too many variables. 

 

OR you can spend the same amount of time to understand your indicators on understanding how big boy's work by analyzing the price & volume. Which is the basis & the core of all indicators. 

 

Please give us a LIKE to support our contribution if you find this blog helpful to you. Thank YOU!

 

Easy way to learn how big boys accumulate shares: https://bit.ly/roundnsurge

Website : www.roundnsurge.com

Facebook: www.facebook.com/roundnsurgeofficial

Youtube: www.youtube.com/c/RoundSurgeoperatoranalysis

Instagram: @roundnsurge

Kelvin's Instagram: @kelvinnny810

 

Malaysia stock market is a unique market, hence it requires a customized trading approach to tackle & swerve. Many existing traders in Malaysia apply a plug-and-play strategy from the overseas stock market, but it is not necessarily the best strategy to trade in KLSE. This is due to the difference in local and overseas stock market regulation and the size of market participants of institutional funds & retail investors.

 

“True traders react to the market.” is the backbone of our trading method. Our findings and strategies are developed through years of trading experience and observance of the operating style in Malaysia’s stock market.

 

Trading Account Opening

They are offering an IntraDay trade brokerage rate at 0.05% or RM8 whichever is higher for day trading stocks RM 50,000 & above-transacted volume (buy sell the same stocks on the same day). Buy & hold at 0.08%or RM8 whichever is higher.

 

Open a cash account now at the link below :

https://registration.mplusonline.com/?ref-id=R311

 

As Kelvin’s trading client, you will be exclusively invited to join Kelvin’s weekly webinar and telegram group. Click here to join.

 

For more inquiry contact him by email: kelvinyap.remisier@gmail.com or 019-5567829

 

If we have missed out on any important information, feel free to let us know and feel free to share this information out but it will be much appreciated if you can put us as the reference for our effort and respect, thank you in advance!

 

This blog is for sharing our point of view about the market movement and stocks only. The opinions and information herein are based on available data believed to be reliable and shall not be construed as an offer, invitation or solicitation to buy or sell any securities. Round & Surge and/or its associated persons do not warrant, represent, and/or guarantee the accuracy of any opinions and information herein in any manner whatsoever. No reliance upon any parts thereof by anyone shall give rise to any claim whatsoever against Round & Surge. It is not advice or recommendation to buy or sell any financial instrument. Viewers and readers are responsible for your own trading decision. The author of this blog is not liable for any losses incurred from any investment or trading.