Logo Crypticorn

Crypticorn

What is the Stochastic Oscillator in Crypto Trading and how to use it!

When it comes to technical analysis, especially for crypto price prediction, the Stochastic Oscillator is one of the go-to indicators for many traders. It provides a more quantitative look into price movements, besting even the RSI in complex market movements.

What is the Stochastic Oscillator in Crypto Trading - Header Picture
What is the Stochastic Oscillator in Crypto Trading – Header Picture

So, in this article, we’ll discuss this popular indicator and how to use it for price prediction. Whether you’re a newbie or an experienced trader, this guide will be helpful in your trading strategy. Let’s dive in.


What is the Stochastic Oscillator?

The Stochastic Oscillator is a technical indicator traders use to determine whether a cryptocurrency or DeFi asset has been overbought or oversold. It is a momentum indicator or oscillator developed in the 1950s by Dr. George Lane, a financial analyst. Thus, it is also called Lane’s Stochastics.

Like the RSI, it uses a range of 0-100 to determine the market’s current condition. Generally, values over 80 indicate that a cryptocurrency or token is overbought, and the price will soon drop. When readings go below the 20 mark, it is likely that the asset has been oversold and may experience a price increase. 

One important thing to note about the Stochastic Oscillator is that it uses two lines, %K and %D, on a chart to determine price movement. The %K line represents the oscillator’s actual value, and the %D line is a three-day simple moving average (SMA) of the %K line. The function of the second is to smooth out fluctuations for easier interpretation.

More practically, when the %K line crosses above the %D line, and both lines are below 20, it may signal a buying opportunity. On the contrary, when the %K line crosses below the %D line and both lines are above 80, it may signal a selling opportunity.

Similar to other momentum indicators, the Stochastic Oscillator also experiences divergence. This occurs when the cryptocurrency or DeFi asset’s price movements are out of sync with the indicator’s. Simply put, when the price of an asset fluctuates to a higher high or lower low than what the oscillator records, divergence occurs.

Although it seems unplanned and somewhat risky, divergence often confirms price trends, making for more decisive entry and exit decisions.

For instance, when the trending price movement goes even lower than the Stochastic Oscillator’s threshold or low, selling sentiment has likely been exhausted, and the trend will likely reverse soon. This means the price of the asset will increase. 

Conversely, a trend reversal may occur when bullish forces exceed the oscillator’s peak value. 

As valuable as the Stochastic Oscillator is, it isn’t without flaws. So, we recommend pairing it with other indicators, such as the Moving Average Convergence Divergence (MACD) and Relative Strength Index(RSI).


What is the Stochastic Oscillator’s Formula

The Stochastic Oscillator uses a relatively simple formula. Since it comprises two lines, both have their individual calculations.

An Example of Stochastic Oscillator by Investopedia
An Example of Stochastic Oscillator by Investopedia

For the %K line:

Formula for the Stochastic Oscillator %K

Where:

  • Current Close is the closing price of the asset for the current period.
  • Lowest Low is the lowest low price observed over the most recent specified period (we recommend 14 periods or 14 days).
  • Highest High is the highest price observed over the same specified period (the last 14 days).

The %D line has a more straightforward formula since it’s the simple moving average of %K. It is calculated by adding the %K values for the most recent three periods and dividing the total by 3 to get the average.


How to use the Stochastic Oscillator

When you apply the Stochastic Oscillator to a TradingView chart or a tool like the Crypticorn AI Price Prediction Dashboard, you can customise three parameters or inputs. These are K, D, and Smooth. K refers to the periods or candlebars the oscillator will work based on. 

  • Setting the inputs: We recommend setting K to 14. D is a 3-period SMA of K, so the value should be 3, and the number you input in Smooth will be the lookback period for the calculation. We suggest you leave it at the default, which is 3. So, it will look at three 14-bar periods, which are 42 days. If your periods are hours, that’ll be 42 hours, almost two trading days. Depending on your expertise, you can customize these parameters to your preferences.
  • Calculate %K: Once you’ve set your parameters, you can calculate %K using the above formula.
  • Interpret %K Values: %K values oscillate between 0 and 100. A reading above 80 usually indicates that the asset is nearing overbought conditions, which means a potential reversal to the downside is imminent. Conversely, a reading below 20 suggests oversold conditions, indicating a possible reversal to the upside. A reading of 50 is neutral, and the trend could move in any direction.
  • Analyze %D Line: The %D line provides additional insight by smoothing out fluctuations in the %K line. A bullish trend may be in order when the %K line crosses above the %D line and both lines are below 20. On the other hand, when the %K line crosses below the %D line, and both are above 80, you should consider selling. 

Say we’re analyzing a cryptocurrency with a 14-day high of $290, a low of $220, and a current closing price of $276. The calculation for the current session’s %K would be:

  • Current close: $276
  • Lowest low: $220
  • Highest high: $290

%K would be:

([276 – 220] / [290 – 220]) * 100

= (56 / 70) * 100

= (0.80) * 100

= 80

80 is considered oversold territory, so this K value suggests a likely trend reversal or a bearish dump in sight, meaning that selling is the most appropriate trading action.

Stochastic Oscillator vs. RSI

The Stochastic Oscillator and the Relative Strength Index are both momentum indicators or oscillators used for crypto price prediction. This means they both measure the speed and strength of cryptocurrencies’ price movements to determine overbought and oversold conditions. However, they have significant differences.

Firstly, the Stochastic Oscillator’s lines are different from the RSI’s. While the RSI has one line oscillating between 0 and 100, the Stochastic Oscillator has two lines. They represent %K and %D, calculated based on the highest and lowest prices observed over the chosen period.

On calculations, the RSI and Stochastic Oscillator have different formulas. The RSI calculates the ratio of average gains to average losses over a specified period, typically 14. The Stochastic Oscillator calculates the highest high and lowest low prices observed over the chosen period.

In addition, when the Stochastic Oscillator’s reading exceeds 80, a DeFi asset or crypto is likely overbought. The RSI, on the other hand, has this value at 70. Oversold conditions, on the other hand, are 20 and 30 for the Stochastic Oscillator and RSI, respectively.

Lastly, the Stochastic Oscillator is typically more sensitive to short-term price movements than the RSI. It is smoother and less susceptible to short-term fluctuations, making it better suited for identifying longer-term trends and potential reversals.

Unlock Your Trading Potential: Enhance Your Strategy with AI-Driven Crypto Price Forecasts
Unlock Your Trading Potential: Enhance Your Strategy with AI-Driven Crypto Price Forecasts

Conclusion

The Stochastic Oscillator is a significant indicator for crypto price prediction. It is a momentum oscillator that calculates recent price movements to determine whether a cryptocurrency has been oversold or overbought. Used well in combination with other indicators, it could enable you to generate profitable entry and exit signals for your trading strategy.


FAQ

How do you use a Stochastic Oscillator in crypto trading?

You use the Stochastic Oscillator to identify and confirm the price trends of a cryptocurrency or DeFi asset. This lets you plot entry or exit points based on whether the asset is oversold or overbought. 

What does a Stochastic Oscillator tell you?

The Stochastic Oscillator tells you when the price of a cryptocurrency is overbought or oversold. These conditions mean that a price reversal is in order. The indicator also helps you spot divergence, which is helpful in trading. 

What are the best settings for the Stochastic Oscillator?

The best settings for the Stochastic Oscillator are K=14, D=3, and Smooth=3. However, these customizable inputs depend on your trading goals and the period you want to trade in.

Leave a Reply

Your email address will not be published. Required fields are marked *

Read Next

Liquidity Management and AI: How Machine Learning Technology Aids Asset Distribution and Accessibility in DeFi

Top 5 Sniper Bots for Profitable Decentralized AI Trading

What Are Crypto Sniper Bots? The best Sniper bot for 100x!

Risks Associated with Crypto Price Prediction and How To Navigate Them

Introduction to Decentralized AI Trading: Exploring Artificial Intelligence and its Applications in DeFi

Top 10 Crypto Discord Trading Signal Servers

Token Sale