The Stochastic oscillator is meant to girate between 100 and 0. A very low level means emotions have caused people to sell in panic. A very high level means emotions have caused people to become too greedy.

Buy when the Stochastic oscillator is low. Sell when the Stochastic oscillator is high. The idea is to take advantage of other traders when they are emotional: either fearful or greedy. Selling when the Stochastic is high is difficult because you’ll want to hang on longer: greed. Buying when the Stochastic is low is difficult because you’ll want to sit on the sidelines longer until the chart looks better.

Newbie traders use indicators by themselves. Don’t do this. Use the Stochastic indicator with other technical indicators. Keep in mind that when a powerful uptrend begins, the Stochastic indicator quickly becomes overbought and begins showing premature sell signals. In a sudden panic sell off, the Stochastic indicator quickly becomes oversold and begins showing premature buy signals. Therefore, this indicator only works if you use it with other trend-following indicators.

What you need to do is to enter a position when the Stochastic indicator is at an extreme. If you try and wait until the Stochastic indicator turns, you’ll miss too much of the move. Think of the extremes of the Stochastic as telling you how much emotion is in the market. The more the emotion, the better you can take money away from other traders.

If you see a positive divergence between the Stochastic and the price of a stock, go long. A positive divergence is when the stock price drops to a new low, but the Stochastic indicator makes only a slight low and does not break to a new low. Do the opposite on the downside. If you see a negative divergence between the Stochastic and the price of a stock, go short. A negative divergence is when prices rise to a new high, but the indicator goes down or barely rises at all.

Perhaps the most helpful use of the Stochastic is in that it tells you when you should NOT buy. Do not buy when the Stochastic is high. Do not short when the it is low. Moving averages are better than Stochastics at spotting trends, the MACD is better at spotting reversals. But the Stochastic is the king at telling you when you should not trade.