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Learn Forex Trading > Day 6 Class  ( Common Chart Indicators ) > Stochastics
Stochastics Oscillator
Developed by George C. Lane, " The Stochastics Man" in the 1950s.

The Stochastic Oscillator tracks market momentum and consists of two oscillator lines, called %D and %K.

Popular types of Stochastic Oscillators are: Fast Stoch and Slow Stoch.
 

Formulas

Two lines are calculated, called %K and %D.

%K compares the latest closing price to the recent trading range, ranging from 0 when the latest close is a new N-day low, up to 100 for a new N-day high;
n = number of periods

%D is a 3-day simple moving average of %K

Overbought / Oversold levels

Oscillator readings below 20% are considered oversold.
Oscillator readings above 80% are considered overbought.

Popular trading signals from Stochastic Oscillator

  • Buy when the Stoch Oscillator (either %K or %D or %K and %D) falls below the oversold level (e.g., 20) and then rises back above that level.
  • Sell when the Stoch Oscillator rises above the overbought level (e.g., 80) and then falls back below that level.

Trending Versus Ranging Market Signals

In trending markets, take only signals in the main direction of the trend. For an up-trending market, only look for oversold conditions, similarly, for a down- trending market, only look for overbought conditions.

I. In trending markets

  • In an up trending market, go LONG if %K or %D falls below the oversold level and then start rising again;
  • In a down trending market, go SHORT if %K or %D rises above the overbought level and then start falling again.

II. In ranging markets

  • Go LONG when %K and %D falls below the oversold level and then start rising back above;

  • Go SHORT when %K and %D rises above the overbought level and then start falling back below.

Positive and Negative Divergences between price and Stochastic Oscillator

One of the most reliable signals to use the Stochastic Oscillator is to wait for a positive or negative divergence to develop from overbought(80%) or oversold levels(20%).

Sell Signal (see above example)

Once the Stoch Oscillator reaches overbought levels, for a SELL signal, simply wait for a negative divergence to develop and then; a cross below the 80% overbought level confirms the negative divergence, a SELL signal is now generated.

Buy Signal

Once the Stoch Oscillator reaches oversold levels, for a BUY signal, wait for a positive divergence to develop after the Stoch indicator moves below 20% oversold level; after a positive divergence forms, a break above 20% confirms the divergence and a BUY signal is generated.

Note: It is recommended to use the Stochastic Oscillator in conjunction with other technical analysis tools to make a complete forex trading system.

Forex Trading Stochastic Oscillator Indicator

The Forex trading stochastic indicator is an indicator that follows the momentum of the market. The stochastic indicator is based on a simple idea. During an uptrend, closing price tend to be high, while during downtrends prices close low.

The Forex trading stochastic indicator warns about the presumed future direction of the Forex trading currency price, based on the assumption the when the currency price rises is closes near the high and when it drops it closes near lows. This way the stochastic oscillator helps analyze a certain trading pattern, whether it is an uptrend or a downtrend.

Using stochastic indicators does not require advanced calculations in most Forex trading sites, since these are included and are done automatically in the Forex Trading Software Online. The current closing price for the stochastic indicator is shown in relation the previous prices over a period of time.

This indicator has two lines:

* %K compares the current Forex trading closing price to the previous trading range.
* %D is a smoothing of %K that is seen as a signal line.

When the stochastic line is above 80%, an overbought signal is given, and when it drops below 20%, the oversold signal is given.

This explanation tells you when to buy and sell using Forex trading stochastic indicator:

  • Buy when the indicator falls below the line, and when it crosses the bottom level up.
  • Sell when the indicator rises above the line, and crosses the top level downwards.
  • Buy when the %K line crosses the %D line from below upwards, or from top downwards.

Basically, the Forex trading stochastic indicator currency's closing price to its price range over a given time period. The sensitivity of the indicator can be lowered by adjusting the time period or by using a moving average of the result.


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