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Stochastic Oscillator is a momentum indicator that was developed by George C. Lane in the late 1950s. It compares a particular closing price of a security to a range of its prices over a certain period of time. The oscillator's sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result.

#What it is and what it shows

The Stochastic Oscillator provides readings that show the position of the current closing price relative to the high-low range over a defined number of periods.

The formula for the Stochastic Oscillator is as follows:

%K = [(Current Close - Lowest Low) / (Highest High - Lowest Low)] x 100

%D = 3-day SMA of %K

Usually, the Stochastic Oscillator is plotted as two lines:

%K which is often referred to as the fast line

%D which is a moving average of %K and can be termed as the slow line

When the Stochastic Oscillator has values above 80, it's usually perceived as an overbought indication. On the flip side, a value below 20 might be seen as oversold. However, these thresholds can vary based on the asset's inherent characteristics.

#How to trade it

The Stochastic Oscillator offers multiple ways for traders to interpret its readings:

Overbought and Oversold: When the Stochastic Oscillator exceeds 80, it can be seen as an indication that the security might be in an overbought condition. Conversely, a reading below 20 may indicate the asset is potentially oversold. It's important to remember that just because the Stochastic Oscillator enters overbought or oversold areas, it doesn't mean a reversal will occur immediately.

Example: If a forex pair has a reading of 85 on the Stochastic Oscillator, some traders might anticipate a potential bearish reversal, especially if other indicators confirm this sentiment.