Created by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that reveals the location of the close compared to the high-low range with a set number of periods.

It follows the velocity or the momentum of price. Most of the time, the momentum changes direction before price. As a result, bullish and bearish divergences in the Stochastic Oscillator can be used to foreshadow trend changes. It was the first, and most important, signal that Lane recognized. Lane also used this oscillator to recognize bull and bear set-ups to predict a future reversal. For the reason that the Stochastic Oscillator is range bound, it can also be great for identifying overbought and oversold levels.

Probably the most trusted setting for the Stochastic Oscillator is 14 periods, that can be days, weeks, months or an intraday timeframe. A 14-period %K will utilize the most up-to-date close, the highest high over the past 14 periods and the lowest low over the past 14 periods. %D is a three day simple moving average of %K. This line is drawn next to %K to act as a signal or trigger line.

Buy and sell signals show up should the %K crosses through a 3 period moving average called the %D.

If the Stochastic is above 80, a stock or market is overbought.

If the Stochastic keeps above 80 it means the uptrend is strong.

In the event the Stochastic falls below the 80 level, anticipate a downward correction or the start of a new downtrend.

As soon as the Stochastic falls underneath 20, a stock or market is oversold.

In the event the Stochastic continues below 20, it means the downtrend is strong.

If the Stochastic breaks above 20, anticipate an upward correction or the beginning of a new uptrend.

There are numerous trading approaches for use with the Stochastic Oscillator but the most effective is the Overbought Oversold system.

First establish the bigger trend in the stock or market you are trading.

Make your Stochastic overlay selecting the Full Stochastic and a setting of 14 and 3.

The Stochastic provides a buy signal when it rises above the 20 line.

It provides a sell signal when it falls below the 80 line.

Another popular trading system that makes use of the Stochastic Oscillator is referred to as the Crossover method.

In the event the %K line from above crosses the %D line downwards it is a sell signal.

Should the %K line from below crosses the %D line upwards, this is the buy signal.

Stochastic line crossovers that take place above the 80% level and below the 20% level are viewed as the most powerful signals when comparing crossovers outside these areas.

Swing traders may wish to increase the sensitivity of the Stochastic Oscillator by using a 5,3 setting which is more desirable for trading fast changing markets.

The next hottest way of trading while using Stochastic Oscillator is called the Divergence method.

In case the price of a stock is hitting new highs but the Stochastic is making new lows, a negative divergence is taking place and it means the price tag on the stock probably will fall.

When the price of a stock is making new lows but the Stochastic is making new highs, a positive divergence has taken place and it means the price of the stock is likely to jump higher.

The aim of this strategy is to locate a divergence regarding the price of a stock and the Stochastic Oscillator.