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How to Read Stochastic Oscillator Properly


There are two completely opposite impressions about Stochastic Oscillator among Forex and stock trader. Some of them swear on this indicator and some others strongly believe that it is nothing but a money sucker.

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I believe it is a great indicator if you know how to read it properly. If you know how to read Stochastic Oscillator, then it is a great indicator. If you don’t know how to read it properly and correctly, and if you don’t know how to use it, then it is a terrible indicator.

There is no difference between Stochastic Oscillator and the other indicators in this case. All indicators, such as Bollinger Bands, MACD, RSI, CCI, ATR, Moving Averages, and… are good indicators if you know how to read them properly. If not, they make you lose most of the time.

The difference of Stochastic Oscillator with the other indicators is that it is a more popular indicator. Many of the traditional stock traders believe on it a lot and have it on their charts as the first indicator that has to be on the chart always. Therefore, it is expected that traders ask about this indicator and the proper way to read and use it. That is why I am always asked “how to read Stochastic Oscillator?” This is the question I am always asked about this indicator more than the others.

In this article, I am going to explain about Stochastic Oscillator in more details. There are several articles about this indicator on this site, but Stochastic Oscillator still needs more explanations and clarifications because improper reading and usage of this indicator still causes so many traders to lose a lot. Make sure to read the below articles as well:

  1. Stochastic Oscillator: A Mechanical Indicator for All Traders
  2. The Safest Way to Use Stochastic Oscillator

How to Read Stochastic Oscillator Properly

Those who have been following me for a while know that I like to simplify everything. This is how it works. Things are sometimes too complicated by themselves. If we make them even more complicated, then it becomes impossible to find the right way.

Reading the Stochastic Oscillator is not an exception. Some traders are used to make it too complicated and invent strange rules for it. But I make it as easy as possible to read Stochastic Oscillator. First, I want to help you to filter out almost all of the false signals and everything that causes you to lose because of Stochastic Oscillator. Second, I show you the only proper and efficient way to read Stochastic Oscillator, so that almost all the positions you take based on this indicator will either be winning positions, or at least they give you the chance to move the stop loss to breakeven to secure your position.

So, here is the rule of thumb to read Stochastic Oscillator properly and efficiently:

  1. Do not pay any attention to Stochastic Oscillator when it is moving between 80 and 20 levels and around the 50 level. It is where that most traders lose because of Stochastic Oscillator.
  2. Analyze the chart and read the Stochastic Oscillator signal when it has broken above the 80 level, or below the 20 level. When Stochastic Oscillator breaks above the 80 level, it is the best chance to take a long position and follow a probable uptrend or strong up move. And, when Stochastic Oscillator is below the 20 level, it is a good chance to take a short position.
  3. Never consider Stochastic Oscillator alone to enter the market. Stochastic Oscillator has to be read when a price action like support/resistance line or level breakout is already formed.
  4. Don’t expect to have a trade setup every day. Reliable and strong trade setups form rarely.

If you follow the above 4 rules that are my own specific rules in reading Stochastic Oscillator, then not only this indicator will never cause you to lose, but also it helps you take good, strong and profitable positions.

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Now, I am going to explain this with some examples.

1. When Stochastic Oscillator Is Moving Between 80 and 20 Levels

As I mentioned, the rule number one to properly use and read Stochastic Oscillator is that you ignore it when it is moving between the 80 and 20 levels.

Stochastic Oscillator goes up and down very fast like the electrocardiogram of a running donkey. Not all of these movements are trading setups and signals. Stochastic Oscillator reflects the price speed and momentum. So it goes up and down when the price starts moving strongly. That doesn’t mean anything because a noisy and choppy market can also cause Stochastic Oscillator to go up and down like crazy.

Avoiding the market when Stochastic Oscillator is moving between the 80 and 20 levels, is a good way to stay away from the choppy, slow and sideways markets that have no proper liquidity for trading. So, Stochastic Oscillator doesn’t just show you the trade setups to enter the markets. It also tells you to stay away from the markets as long as it is between the 80 and 20 levels. This is the first and most important thing you have to know and learn when you start learning how to read Stochastic Oscillator properly and efficiently.

Therefore, the the below zone is where you have to stay away from the market and trading:

How to Read Stochastic Oscillator

2. When Stochastic Oscillator Has Broken Above the 80 Level or Below the 20 Level

When Stochastic Oscillator is above the 80 level or below the 20 level, is the best time to read it. However, it doesn’t mean that you can enter the market just because Stochastic Oscillator has broken above the 80 level or below the 20 level. The 3rd rule which is a very important rule in reading Stochastic Oscillator signals is that a price action like a support/resistance line/level breakout has to form while Stochastic Oscillator is already above the 80 or below 20 levels.

3. Price Action When Stochastic Oscillator Is Above the 80 or Below 20 Levels

Above the 80 level and below the 20 levels are called overbought and oversold respectively. But when Stochastic Oscillator is above the 80, it doesn’t necessarily mean that the market is overbought and (1) it will reverse, or, (2) it can’t go higher.

It is the same when Stochastic Oscillator is below the 20 level: It doesn’t mean that it will reverse and will go up and it can’t go lower.

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Indeed, the price can go much higher when Stochastic Oscillator is above the 80 level or in the overbought area. This is when the market is going up and is forming a strong uptrend which is the best time to enter the market and make profits. This is the best time to consider and read Stochastic Oscillator signals. It is the same when Stochastic Oscillator is below the 20 level.

Now, to make sure that the price will keep on moving toward a special direction strongly, and will form a strong movement that is worth entering the market and risking some money, you have to look for a proper and valid price action like a support or resistance breakout. This is how to read Stochastic Oscillator properly.

When Stochastic Oscillator has broken above the 80 level, you have to check the price and locate a resistance breakout. Sometimes Stochastic Oscillator breaks above the 80 level a few candlesticks after the resistance breakout was formed. Sometimes they almost form at the same time. Or when a candlestick closed above a resistance, Stochastic Oscillator also goes above the 80 level just when the next candlestick opens. These are all good.

The other important point is that as Stochastic Oscillator goes up and down very frequently, it will leave the overbought area after a resistance breakout and a long trade setup and while the price is still going up. This is normal. If Stochastic Oscillator leaves the overbought area and goes down, it doesn’t mean that you have to close your long position. You read the Stochastic Oscillator signal only when a price action like a resistance breakout forms while Stochastic Oscillator is above the 80 level. It doesn’t matter what will happen to Stochastic Oscillator after that.

In the below chart which is EUR/GBP monthly chart, I am showing you several trade setups. The middle one is the best one. Try to open the same chart on your trading platform and locate and analyze the same trade setups:

Stochastic Oscillator on EURGBP Monthly Chart

This is EUR/USD monthly chart. Analyzing the previously formed trade setups is a best teacher to tell you how to read Stochastic Oscillator properly. As you can see in the below chart, using the Stochastic Oscillator and also technical analysis, you can locate several profitable trade setups that can make thousand of pips:

Stochastic Oscillator on EUR/USD Monthly Chart

4. Avoid Over-Trading

You have to wait for the strong and reliable trade setups and avoid the questionable and weak ones. When you trade the longer time frames like monthly, you can also combine the technical analysis with the overall economic situation of the markets and take better decision. Reliable and strong trade setups rarely form, but they help you have long-term investments and increase your wealth: Make Money with Forex the Right Way

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That was just a short article on how to read Stochastic Oscillator properly. I will write about this indicator more. Make sure to read the future posts.

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Chris Pottorff

"Whether you think you can, or you think you cannot, you are right." - Henry Ford

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4 thoughts on “How to Read Stochastic Oscillator Properly
  1. Niki Nanaimo Niki Nanaimo says:

    Dear Chris, great article, as always 🙂 Couple questions:
    — Is it possible to use +100/-100 CCI value in the same way as 80/20 for Stochastic Oscillator? Could you quickly elaborate?
    — Is there any indicator value or behaviour (except BB) that can confirm or devalue strong candlestick pattern?
    Thank you! All the best! 🙂

  2. This article is really excellent Chris! Thank you. I follow and utilize your regular system quite regularly (the bollinger band reversal system). Do you ever utilize that system along with the stochastic oscillator? Also, the stochastic reminds me of the RSI and the system your protege Kamel designed (the one that uses slow MACD + RSI + 4 day MA). Why not use stochastic with that system instead of using RSI?

    Thanks again!

    • LuckScout LuckScout says:

      > Do you ever utilize that system along with the stochastic oscillator?

      No.

      > Why not use stochastic with that system instead of using RSI?

      You can have both of them with this system as well.

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