Stochastic is a simple momentum oscillator developed by George C. Be ing a momentum oscillator, Stochastic can help determine when a currency pair is overbought or oversold. Since the oscillator is over 50 years old, it has stood the test of time , which is a large reason why m any traders use it to this day.
Slow stochastic is found at the bottom of your chart and is made up of two moving averages. These moving averages are bound between 0 and 10 0. Traders are constantly looking for ways to catch new trends that are developing. As a result, a trader using stochastic can see these shifts in trend o n the ir chart. Momentum shifts directions when these two Stochastic lines cross.
Therefore, a trader takes a signal in the direction of the cross when the blue line crosses the red line. As you can see from the picture above, the short term trends were detected by Stochastic.
However, traders are always looking for ways to improve signals so they can be strengthened. There are two ways we can filter these trades to improve the strength of signal. Some signals are stronger than others. The first filter we can apply to the oscillator is taking cross overs that occur at extreme levels. Since the oscillator is bound between 0 and , overbought is considered above the 80 level. On the other hand, oversold is considered below the 20 level.
Therefore, cross downs that occur above 80 would indicate a potential shifting trend lower from overbought levels. Likewise, a cross up that occurs below 20 would indicate a potential shifting trend higher from oversold levels. The second filter we can look to add is a trend filter. If we find a very strong uptrend, the Stochastic oscillator is likely to remain in overbought levels for an extended period of time giving many false sell signals.
We would not want to sell a strong uptrend since more pips are available in the direction of the trend. Therefore, if we find a strong uptrend, we need to look for a dip or correction to time a buy entry. That means waiting for an intraday chart to correct and show oversold readings.
At that point, if Stochastic crosses up from oversold lev els, then the selling pressure and momentum is likely alleviated. This provides us a signal to buy which is in alignment with the larger trend. Therefore, if we filtered trades according to the trend on a daily chart, then only the long signals green arrows would have been taken. Therefore, traders us e Stochastic to time entries for trades in the direction of the larger trend.
Try it out for yourself. Try it out for yourself in a practice account. Not sure how to manage your risk on a trade? Fast Stochastics vs Slow Stochastics 46 of The Relative Strength Index.
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets. Move Back Below 1. Click here to dismiss. How to Trade with Stochastic Oscillator. Swing trading, chart patterns, breakouts, and Elliott wave Connect via: Foundations of Technical Analysis: Classic Chart Patterns, Part I.
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