All indicators have their strengths and their weaknesses. It is important to know this for any indicator so that we can use an indicator for conditions that it is best suited for. In the case of the stochastic indicator, most people look at this as a tool to identify overbought and oversold conditions.
The Stochastic indicator ranges from 0 to 100. Anything over 80 is considered to be overbought and anything under 20 is considered oversold. The typical period used is a 14 period which would represent looking at the last 14 weeks if on a weekly chart, the last 14 days on a daily chart, the last 14 hours on an hourly chart, etc. The indicator looks at the close of the 14 period, and then compares with the high and low of that 14 period. The stochastic indicator looks to see if the current close is at the high or low end of the range or somewhere in between. When a strong trend is occurring, the indicator is going to be in an overbought or oversold area and can stay there for some time. Looking for a reversal based on stochastic over 80 or less than 20 is best used when you are in a trading range, not a strong trend.
However, stochastic can still be helpful if you have a strong trend. You would use stochastic to look for divergences. In an uptrend, you have higher peaks. If the peaks on stochastic are getting lower during an uptrend, this is a sign of the trend weakening and a potential reversal. The same applies to a downtrend, where you have lower dips. If the stochastic dips are going higher, you have a divergence, indicating strengthening and a potential reversal.
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