Hi Everyone,
I was reading about Stochastic Oscillators and one of the topics which came up was divergence.
It is loosely defined as follows:
A divergence occurs when the indicator doesn’t move in-line with price. For example , the price makes a new high, but the stochastic fails to reach a new high. Or, price makes a new low, but the stochastic fails to make a new low.
Diagram Below:
I’m having a hard time reconciling this in my head how this is possible, how can the price finish higher however get marked lower on the oscillator? It just seems a little bit contradictory to me.
The %K is defined as (Current Price - Low)/(High - Low)
If the most recent close price is a higher, this should get a higher score on the oscillator, not lower. Under what scenario would a higher price get marked lower on oscillator?
Not sure what I am misunderstanding here, would appreciate if anyone could point me in the right direction.
Thanks!
1 Like
You obviously have not read the babypips course. Therefore you have not researched george lane. Stochastic is a measure of price momentum. If price goes higher but momentum slows down then the oscillator will make a lower high.
Please complete the babypips course.
1 Like
I went through the babypips article on Stochastic Oscillators already, I understand what it is supposed to measure and how it behaves conceptually, but it’s not intuitive to me how the following divergence behaviour can happen in a real price series.
If price goes higher but momentum slows down then the oscillator will make a lower high.
I don’t understand how the oscillator can mark a lower high if the price reaches consecutive highs. I understand that it’s what actually happens during divergence behaviour, but not sure why. It’s not really a question on ‘what’ but ‘how’.
I think I might be getting confused with the formula?
%K1 = (Current Price A - Low)/(High - Low)
%K2 = (Current Price B - Low)/(High - Low)
If Current Price B > Current Price A, how can %K2 < %K1?
From what I have read online, a lot of places tell you what happens (as per the quote above) and say it is because momentum is slowing, but not clear to me how the oscillator is measuring this momentum, and why it would think the momentum is slowing even when the price continues to increase?
Hope my question is clear, and apologies if I am missing something blindingly obvious!
Bro you’re getting all maths technical. So %k is the fast oscillating and what you call k2 is called %D which is the 3 day moving average of %k. In divergence as price is increasing the %k makes a high but when price goes higher it makes a lower high.
The formula is :
100 x (closing price -L5) / (H5-L5)
L5 H5 are low and high of last 5 periods. You can change the 5 to whatever you want on the settings of the indicator.
So price makes a high and the stochastic calc comes to 93%. Then, if price makes a second high but that H5 is further from the L5 than in the first peak. This makes the lower denominator higher then the answer will come out lower. Thereby a lower low on the stochastic as momentum is lower than original peak or prices are closing further from the high.
When you do the babypips course they have links attached on every page where the words are green. You should click them to read around the subject.
I dont think @hoangjames is talking about %D.
He’s asking how can price go Up on time while the oscilator goes down, creating a divergence.
I personally dont use stochastic oscilator divergence, but It can ocur if you measure with more separation between periods. Dont measure K1 and K2, you may see this if you measure in K1 and K5 maybe. What you may see is that price is in a downtrend, so It forms a lower low, while the oscilator forms a higher low. Here you have an example.
Stoch Osc. Divergence
However there are many other uses of the oscilator:
- overbought/oversold áreas
- a divergence in the %D that @tradeforex077 mentioned, that is the oscilator’s own moving average. - Also When K crosses D, it’s considered a Signal by some tech. Analysts
Good luck!
Yep. That’s why I explained why it happens. The formula works out where price is compared to the recent range. So when price is closing towards the low of the period it shows momentum is reducing as more people are not closing higher.
Thanks for the replies so far. When I said %k1 and %k2 above I was not referring to %D, rather just referring to the values of %K at different points in time. Based off your answers, I think I understand this a little better now. I think I was not considering the look-back window, especially if one of the points at the end are the respective high/low of that time period.
The formula is :
100 x (closing price -L5) / (H5-L5)
L5 H5 are low and high of last 5 periods. You can change the 5 to whatever you want on the settings of the indicator.
I did not consider the case where the high/low might get ‘chopped off’ due to the time window.
eg. The ‘low’ for the peak @90 is 50, whereas the low for the peak @95 is 89. So your momentum is only relative to the look-back window you are considering.I think that makes sense Thanks!
