Stochastic Oscillator Indicator Guide for MT4/MT5

The MT5 stochastic oscillator indicator is a range-bound indicator developed by “George C. Lane” in the late 1950s. This two-line indicator oscillates between 0 and 100. Due to its adaptability, the stochastic oscillator MT4 Indicator remains one of the most popular technical indicators used in the Forex and crypto markets. It is helpful in predicting trend reversals and also focuses on price strength, allowing us to identify overbought and oversold areas. In this guide, I will explain how to use the Stochastic indicator for MetaTrader 4 and 5.

What is stochastic oscillator indicator ?

The stochastic oscillator is a technical indicator that compares a specific closing price of an asset to the high-low range of its prices over a specified period of time. Typically, we employ 14 previous periods. For example, when using a weekly chart, this translates to 14 weeks, and on a daily chart, it represents 14 days. Consequently, we can control the indicator’s sensitivity to market movements and changes by modifying and adjusting the time periods. Essentially, the stochastic oscillator strategy typically consists of two lines: the %K and the %D. The %K reflects the actual value of the oscillator for each session, while the %D represents the three-period SMA of %K. Effectively, this two-line indicator oscillates between 0 and 100 and can be applied to any chart and any timeframe.

Indicator Formula

We calculate the stochastic oscillator as follows:

%K = 100 * [ ( C – L14 ) / ( H14 – L14 ) ]

Where

%K: The present value of the stochastic oscillator.

C: The most recent closing price of the instrument.

L14: The instrument’s lowest price of the 14-periods.

H14: The instrument’s highest price of the 14-periods.

%D= 3-period simple moving average of %K.

We can insert the stochastic oscillator from the indicator list in both platforms Metatrader and Tradingview.

How to trade with it ?

The MT5 stochastic oscillator offers a variety of applications. As a general rule, when the stochastic oscillator is at a high level, it indicates that the asset’s price closed near the top of the 14-period range. Conversely, when the indicator is at a low level, it suggests that the price closed near the bottom of the 14-period range. As the indicator fluctuates between 0 and 100, we can interpret different readings:

The stochastic oscillator provides valuable insights into the price movements of an asset. By analyzing the indicator’s readings, traders can make informed decisions about their trading strategies.

A Reading above 80:

• An indicator value above 80 indicates that the asset is trading near the top of its high-low range. This suggests that the asset is overbought and may be due for a correction.

• A value below 20 suggests that the asset is trading near the bottom of its high-low range. This indicates that the asset is oversold and may be poised for a rebound.

A Reading above 50:

• A reading above 50 signals that the asset is trading within the upper portion of the trading range. This suggests that the asset is trending upwards.

• A value below 50 indicates that the asset is trading in the lower portion of the trading range. This suggests that the asset is trending downwards.

The stochastic oscillator aims to anticipate turning points by comparing the closing price to previous price movements. This allows us to generate overbought and oversold trading signals. Now, let’s explore how to utilize the stochastic oscillator on TradingView to identify crucial areas.

Detecting overbought and oversold areas

The stochastic oscillator helps us assess whether an asset is overbought or oversold by comparing the closing price to previous price movements. When the indicator lines are above 80, we can infer that the asset is overbought. Conversely, when the lines are below 20, we consider the asset oversold. Therefore, in a basic overbought and oversold strategy, Forex traders can utilize the MT4 stochastic oscillator to identify entry and exit points. Typically,a buy trade can be placed for an oversold asset. We often detect this buy signal when the stochastic oscillator drops below 20 and then rises above it. In contrast, a sell trade should be applied when the asset is overbought. We frequently identify a sell signal when the indicator exceeds 80 and then falls below it. Overbought and oversold zones are indeed useful for predicting trend reversals.

However, it’s important to remember that we can’t always rely on overbought and oversold levels, as they can be misleading. Forex traders should be aware that an asset won’t necessarily drop in price just because it’s considered overbought. Similarly, an asset won’t automatically rise in price just because it’s considered oversold. These areas simply indicate whether the asset is approaching the top or bottom of its price range.

Identifying divergences

Another popular MT4 stochastic oscillator strategy involves identifying divergences. In this approach, Forex traders look for situations where the asset is making new highs and lows while the indicator is not. This can be a signal that the current trend is losing momentum and may soon reverse.

In this context, a bullish divergence occurs when the price of a given asset forms a lower low, while the indicator makes a higher low. This indicates that selling pressure is decreasing, and an upward reversal may be inevitable. Conversely, a bearish divergence arises when the price forms a higher high, but the indicator makes a lower high. This indicates that the upward trend is slowing, and a downward reversal may occur. However, it’s crucial for Forex traders to confirm the divergence with a genuine reversal, as the asset price can continue rising or falling for an extended period, even amidst divergence.

Using crossovers

The MT5 stochastic oscillator crossover is also a well-established strategy among Forex traders. The intersection of the two lines is considered a potential indication of a forthcoming reversal, as it signifies a significant shift in momentum. This occurs when the two lines cross within either the overbought or oversold zone. On one hand, when an ascending %K line crosses above the %D line during an oversold period, it suggests a buying opportunity (long position). On the other hand, when a descending %K line crosses below the %D line during an overbought period, it signals a selling opportunity (short position). However, these signals tend to exhibit greater accuracy in range-bound markets, while their reliability diminishes in trending markets.