What is the Stochastic Indicator
Created by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the strength of a trend for a certain period of time. Stochastic is a number between 0 and 100 where the reading below 20 is considered oversold and the reading above 80 is considered overbought. To create stochastic:
1. %K = (Ctoday - Ln)/(Hn - Ln) * 100, where
Ctoday = today's close.
Ln = the lowest price for the selected number of days.
Hn = the highest price for the selected number of days.
n = the number of days for Stochastic, selected by the user.
You don't have to know how to calculate the stochastic indicator as most software will automatically calculate the value for you.
How Does The Stochastic Indicator Work
Stochastic is one of my favorite technical indicators and it is extremely powerful when you use it properly. Here are a few ways how you can use the stochastic indicator to find profitable stock setups.
1. A bullish signal is generated when the stochastic crossover (signal line cross occurs when %K crosses %D).
2. You can add a stock to your watchlist when the stochastic is in the oversold area (below 20), and wait for the stochastic to cross above 20 which indicates the stock may recover.
3. Stochastic Divergence - stochastic divergence is a leading indicator that for a stock. If the stock is in a down trend, but the stochastic indicator keeps trending higher, that is an indicator that the stock may recover any time soon.
4. If you are shorting a stock, you can add a stock to your watchlist when the stochastic is in the overbought area (above 80) and wait for the stochastic to cross below 80 which indicates weakness. You can also use the bearish stochastic divergence to short stocks. When a stock keeps going higher, but the stochastic indicator trending lower, that means the trend for the stock may end any time soon and the stock trend will reverse.
Let's see how the stochastic indicator works on a stock chart. The stochastic indicator moves in the oversold area (below 20) in the mid April. That's when you should add the stock to your watchlist, because you want to wait for the stochastic to cross above the 20 level. The stochastic crossover above 20 at the end of April, but failed to make any move. However, the stochastic was in the oversold area again in May and it soon crossed above the 20, and this time the stock takes off. The Sprint stock then went from $2.5 to $5.5 in a few months.
The stochastic is a great technical indicator, but it should be combine with other indicators for best results. You can combine it with MACD, ADX,
Candlestick or any other technical indicators.
How To Scan For Stochastic Crossovers
Searching for these stochastic crossover manually is a lot of work, you can use our stochastic screener to save you time.
1. Go to Stock Screener
2. Find the Stochastic Crossover Screener
3. Select value between 20 & 25, and hit the Submit button. This will give you a list of stocks that are crossing over from the oversold area. You can
adjust the setting to below 20 if you want to return stocks that are in the oversold area.
If you are shorting stocks, you can use our bearish stochastic screener.