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The Stochastic Oscillator is a momentum-type indicator that determines overbought and oversold positions. In other words, it can provide a trader with information on when to enter or leave the market. The indicator is also used to predict future performance of the underlying asset. It was created and introduced by George C. Lane in the 1950s.

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The Stochastic Oscillator on the IQ Option trading platform

How does it work?
According to Lane himself:"“The indicator doesn’t follow price, it doesn’t follow volume or anything like that. It follows the speed or the momentum of price. As a rule, the momentum changes direction before price.”"This indicator, therefore, is capable of predicting trend reversal points, which is crucial for successful trading.

The Stochastic Oscillator returns the ratio between the last closing price and the high-low range during a set period of time. It is based on the premise that during the uptrends, prices will be above the previous period closing price. Alternatively, during the downtrends, prices will likely be below the previous closing price.

During the uptrend the SO is likely to stay above the green line

The oscillator consists of two horizontal and two moving average lines (the fast and the slow ones). The fast moving average line is by default has a period of 3, while the slow MA has a period of 13. The oscillator ranges from 0 to 100. Both levels, by default set at 20% and 80% respectively, coincide with two horizontal lines.

When the fast and the slow moving averages remain above the 80% level, the asset is being bought too aggressively. When both lines remain under the 20% level, everyone is trying to get rid of the asset. It should be noted, however, that the decrease in prices is not necessarily a signal to buy, as securities can remain in the oversold zone for quite some time without leaving it. Similarly, an upward price rally does not always indicate an urge to open a “Put” position. Securities can remain overbought for relatively long periods of time during a strong uptrend.