Overbought vs Oversold - What do the Stochastic Levels mean?

6 juin

There is a lot of speculative information around the Stochastic RSI and its levels. Many strategies are just outright wildly false for example talking about crossovers of levels but I want to give you guys some insight of what these levels actually mean to help you better use the stochastic RSI. In this article I mention many levels but I want to focus on the 50 level or the MIDLINE depending on the Stochastic that you use.

I want to point out something very important here. The Stochastic was LEVER meant to be used as an entry exit tool so if youre trying to find the perfect settings to tell you when to GO / NO GO, stop looking. There arent any. No perfect timeframe, no perfect lengths, etc.
THis is to be used in combination with other tools and analysis to help confirm whats about to happen. The stochastic is lagging like any other indicator. But its calculation is very fast so you need to devise a plan of action on your charts well before putting it into use.

This articles content is based on a few things:
My experience with the Stochastic.
How it's math works.
What does momentum mean across an oscillator.
The physics of momentum and force. (Science stuff huh?)
So lets get into it.



First off if you want to get your hands on my special and custom version of the Stochastic, you can. Its on called "The Stocashi" A Heiken Ashi version of the stochastic with a few hidden features.

STOCASHI + Caffeine Crush: A heiken ashi stochastic


The Big Issue At Hand is the Stochastic 50 (mid level) value and what does it mean.
Let's talk about the Mid-Level (50) in the Stochastic Oscillator

Neutral Point - Midline
The 50 level in the Stochastic Oscillator represents a neutral zone where neither bullish nor bearish momentum is dominant. It is the midpoint between the extremes (0 and 100 in the traditional Stochastic).

Momentum Indication
Above 50: When the %K line is above 50, it indicates that the asset is gaining bullish momentum. The higher the value, the stronger the bullish momentum.

Below 50: When the %K line is below 50, it indicates that the asset is experiencing bearish momentum. The lower the value, the stronger the bearish momentum.

Trend Confirmation and Reversals
Crossing Above 50: If the %K line crosses above the 50 level, it may signal the beginning of a bullish trend or an increase in bullish momentum. Traders might look for additional confirmation from other indicators or price patterns.

Crossing Below 50: Conversely, if the %K line crosses below the 50 level, it may indicate the start of a bearish trend or an increase in bearish momentum.

Strength of Momentum
The distance from the 50 level reflects the strength of the current momentum. The farther the %K line is from 50, the stronger the momentum:

Near 100: Indicates strong bullish momentum.
Near 0: Indicates strong bearish momentum.
Near 50: Suggests weak or neutral momentum, which could mean consolidation or indecision in the market.

Market Conditions
Overbought/Oversold: Traditional overbought and oversold levels (80 and 20, or in your adjusted version 50 and -50) provide additional context:
Overbought: %K above 80 (or 50 in your version) suggests the asset might be overbought and due for a correction.
Oversold: %K below 20 (or -50 in your version) suggests the asset might be oversold and due for a bounce.

Relative Strength
The mid-level can also be seen as a relative strength indicator. Staying above 50 for extended periods indicates sustained strength, while remaining below 50 indicates sustained weakness.

Practical Interpretation
Trend Identification:
When the %K line is consistently above 50, it indicates that the asset is in an uptrend. Traders may use this information to stay long or look for buying opportunities.
When the %K line is consistently below 50, it suggests a downtrend. Traders might use this to stay short or look for selling opportunities.

Signal Filtering:
Crossovers of the mid-level can be used to filter signals. For example, a buy signal might be considered more valid if the %K line is crossing above 50, while a sell signal might be more valid if the %K line is crossing below 50.

Consolidation and Breakouts:
When the %K line hovers around 50, it can indicate a period of consolidation. A breakout from this zone can signify the start of a new trend.