As Stochastic Oscillator /

Introduction

     Stochastic is the most popular momentum indicator after RSI and MACD. Primarily its used by short-term traders because it the indicator follows the market's movement quite fast, although it leads to more false signals. 
Invented by George Lane in the 1950s.

     According to Lane, the Stochastics indicator is to be used with cycles, Elliot Wave Theory and Fibonacci retracement for timing. In low margin, calendar futures spreads, one might use Wilders parabolic as a trailing stop after a stochastics entry. (Wikipedia)

Stoch is used for predicting reversal points / possible bottoms and tops, trend change.

     The indicator consists of two lines:

%K compares latest closing price to recent range.

%D is the signal line calculated by smoothing %K.

      How to calculate Stoch? -> %K = (recent close - lowest low) / (highest_high - lowest_low)

Overbought/oversold conditions, signals

     When the Stoch is above the level of 80, we say that the pair is in an Overbought situation and we look only for short positions.

     When the Stoch is below the level of 20, we say that the pair is in an Oversold situation and we look only for long positions.

Only an example. In this case Stoch didn't work well, but at other situations it can.

Buy signal appears when %K line rises above the %D line and sell signal appears when the %K line falls below the %D line.

A picture could be also attached, but there is no point in doing that - there a lot of signals generated by that which means a lot of false signals and it's simply senseless to show on chart. Because of that, It's not advised to take signals generated by %K line and %D line crossing.

Divergence

     Divergence indicates that a reversal will be seen. Look for situations when the price is making series of new highs, but Stoch doesn't, and making series of new lows. As you could see on previous chart, the volatility is quite high on histogram which leads to less reliable divergence signals and harder recognition.

Important

     Signals (as always) more reliable on higher timeframes than M5 and M15. No signal, no trading!

     The effectiveness can be also raised if we wait for confluence from other indicators aswell. The more indicators support the signal, the more reliable the signal is.

(Written by Stockwalker 20th of June)