Hence, by default, the MetaTrader 4 trading platform shows a slow stochastic based on an additional 3 period moving average. On the other hand, if you stick to the original Stochastic Oscillator formula, then it would be called a fast stochastic. To calculate a fast stochastic using MetaTrader 4 and other charting software, you need to set the value of slowing to 1.
The Stochastic Oscillator offers Forex traders three different types of signals. Depending on the market conditions, these three signals can be interpreted differently. Therefore, it is imperative that you learn to identify the market condition before trying to interpret the Stochastic Oscillator signals. Often the most used Stochastic Oscillator signal is the overbought and oversold market conditions.
As we discussed earlier, the Stochastic Oscillator is plotted on a fixed scale, and its value stays within 0 and When the Stochastic Oscillator value goes above the reading of 80, it is considered to be an overbought market condition, which signals that if you already have a long position, you should start reducing your position size or actively look for opportunities to sell the underlying asset. By contrast, when the Stochastic Oscillator value goes below the reading of 20, it is considered to be an oversold market condition, which signals that if you already have a short position, you should start reducing your position size or actively look for opportunities to buy the underlying asset.
While the overbought and oversold signals generated by the Stochastic Oscillator is quite reliable, it is worth noting that these signals work best during a range bound market. However, during an uptrend market, the Stochastic Oscillator becomes overbought, and during a downtrend market, the Stochastic Oscillator becomes oversold very quickly and gives an illusion that the market is about to reverse. Beginner Forex traders often complain that they placed a buy or sell order during an uptrend or downtrend after seeing an overbought or oversold signal generated by the Stochastic Oscillator, which resulted in a loss.
If you decide to counter trend trade using the Stochastic Oscillator signals during a trending market, you will get beat up quite badly. During a trending market, you should apply additional filters such as trend lines and other trend reversal indicators to confirm if the trend is ending or it has already reversed before taking counter trend Stochastic Oscillator signals seriously.
Once again, these Stochastic Oscillator crossover signals are reliable during a range bound market, but these signals tend to become a lot less reliable when the market is in a strong trend. However, you can still rely on the Stochastic Oscillator crossover signals as a trend continuation signal and open additional positions. It indicated that the uptrend is likely to continue and the market did continue upwards.
Similarly, if you see a crossover sell signal during a downtrend, you can also rely on the signal as supporting evidence that the downtrend is likely to continue. This type of trend continuation signal tends to be reliable during trending markets. However, you should take caution and apply additional filters before trading against the trend using the Stochastic Oscillator crossover signal. The last type of signal generated by the Stochastic Oscillator is called divergence signals.
Stochastic Oscillator can generate both trend reversal and trend continuation divergence signals. The trend reversal signal is referred to as regular divergence signals, and the trend continuation signal is known as hidden divergence signals. The stochastic divergence signals tend to be the most powerful and reliable of all the different types of Stochastics generated signals.
When price makes a lower low, but the stochastic oscillator fails to confirm and instead makes a higher low, this is considered a Bullish Stochastic Divergence signal. When price makes a higher high, but the stochastic oscillator fails to confirm and instead make a lower high, this is considered a Bearish Stochastic Divergence signal.
Such conditions are known as a trend reversal divergence signal. As you can see in figure 4, the GBPUSD price continued to go down while the Stochastic Oscillator continued to move up, which generated a classic regular bullish divergence. This type of market condition is known as regular bearish divergence. When you find a regular divergence , you should discount the Stochastic Oscillator crossover signal as it would often turn out to be a false signal.
For example, in figure 4, the first few Stochastic Oscillator signals generated during the regular bullish divergence proved to be false. Therefore, if you see a regular divergence, the best way to enter the market would be to apply a second uncorrelated technical indicator or price action signal. As you can see in figure 4, if you have waited for the GBPUSD price to break above the downtrend line after the formation of the regular bullish divergence, the trade would have yielded a profit, assuming you decided to exit after recognizing the bearish divergence afterwards.
Hidden divergence is a trend continuation signal, and the Stochastic Oscillator can be used to find these occurances. If you learn to combine the crossover signal with hidden stochastic divergence, it can offer some good trading opportunities. A hidden bullish divergence occurs when price is making a higher low, but the oscillator is making a lower low.
And on the flip side, a hidden bearish divergence occurs when price is making a lower high, but the oscillator is making a higher high. It cannot just turn and fall down in an instant. It slows down first, then dips its nose before the dive.
What do we learn from this? Momentum change comes first before the change in direction, and that rule also applies in forex. Both, the stochastic oscillator and RSI indicators, are momentum oscillators, meaning that they are both used to predict market trends. However, how they go about achieving that is the main reason why they are so different.
Although the RSI indicator is more widely used among analysts and traders alike, both are excellent indicators. RSI was developed by J. Welles Wilder Jr. It compares recent gains to recent losses in a market. The RSI indicator measures overbought and oversold conditions by looking at the velocity of the price movements.
The RSI forex indicator is displayed as a line with a value from 0 to , with 50 being the midline point. If the RSI indicator crosses over 70, that indicates an overbought condition. If the number dips below 30, it is an oversold condition. The RSI indicator can also be used to identify the support and resistance zones , to identify potential trend reversal points, or to verify the signals coming from other indicators such as Bollinger bands forex or trendline trading.
The stochastic oscillator was developed by George land. It works on the assumption that the closing prices should close in the same direction as the trend. Similar to the RSI indicator, the stochastic oscillator displays a value from 0 to If the lines peak above 80, that indicates an overbought condition.
If they drop below 20, that is an oversold condition. Unlike the RSI indicator, the stochastic oscillator displays two lines. One that reflects the true value of the oscillator for the session and the other being an average value of the last three days. For instance, a market with a bearish trend with prices dipping for newer lows and the stochastic oscillator displaying higher lows suggests that the trend is about to lose its momentum and a trend reversal is near.
For the RSI indicator, such a divergence also suggests the same thing. So, which one is better? That depends on the market. The RSI indicator performs better in a turbulent and volatile market with lots of ups and downs in consistent ranges. On the other hand, the stochastic oscillator does well in a market with a sideways trend.
The stochastic oscillator is an indicator among a plethora of others in the forex platform to help traders identify the momentum of the price change and identify potential trend reversals. The momentum is calculated by comparing the closing price to the trading range over a certain period of time. There is not much going on until the two lines intersect, which indicates that a pullback or a shift in trend may be imminent.
For example, suppose that you are looking at the chart displaying GBPUSD with a bullish trend with the stochastic oscillator indicator. Then, you notice the indicator displaying a downward cross through the signal line. That means, the latest closing price is closer to the lowest low of over the look-back period than it has been in the last three sessions.
That means that the trend may start to lose steam allowing a pull back or reversal to take place even though it is strong in the bullish momentum. Similar to other momentum oscillators such as the Relative Strength Index indicator, the stochastic oscillator can also be used to determine overbought or oversold conditions. It has a range from 0 to , with the value over 80 indicating overbought conditions and 20 indicating oversold conditions.
The and the zone indicates how strongly the price action is in momentum. If the lines intersect at above 80 or below 20, it is a strong signal of an imminent trend reversal or a pullback as compared to the crossover if it occurs between 20 to One strategy for using the stochastic oscillator is to look for a currency pair with a pronounced and lengthy bullish trend. Ideally for a reversal, you want to see a currency pair that has been in the overbought territory for a while with their prices peaking at a previous resistance zone.
Then, look for the waning volume since that serves as another indication of the bullish trend losing steam. When the stochastic oscillator crosses the signal line, the price will soon follow. Although the signals are already clear, it is best to wait for the price action trading bar to dip first before making the move since momentum oscillators tend to spit fake information now and again.
However, the strategies and techniques we will discuss below make use of the default values, which are 14, 3, 3 K, D, and Smooth, respectively. There are two deadly mistakes a trader can make when using the stochastic oscillator that can conclude his career. Avoid these mistakes, and you will see yourself making hundreds or even thousands of dollars in profit soon enough. The stochastic oscillator measures the momentum behind price changes.
When the indicator reads above 80 overbought , it indicates strong bullish momentum. What would be your first instinct? If you go short because the stochastic indicator says there is an overbought condition, you are in for a painful surprise. Going in blind like this is a huge mistake since the market can continue to be overbought or oversold for a long time.
Likewise, the opposite is to be hold true. As mentioned before, a divergence occurs when the price keeps peaking and producing higher highs but the indicators show lower highs. That means there is a difference, a divergence, between the prices and the stochastic indicator. This tells us that, according to trading courses or textbooks, a trend reversal is imminent.
Of course, the bigger the winning rate, the better. Risk management or money management plays an important role. Most of the times, traders face difficult decisions. In theory, it sounds very simple. Or to let profits run.
Everyone agrees with that. Yet, this is a difficult thing to put into practice. The stochastic oscillator comes to help with this decision. As often is the case, retail traders end up losing money despite correctly reading the market. Greed and fear are the worse enemies. Discipline and patience matter the most, while an indicator like the Forex stochastic one comes to help.
Its biggest advantage is visibility. Traders see any signals generated and have plenty of time to react. This is especially true if the time frame is big enough. Another plus comes from its characteristics. It is essentially following the market. The currency pair makes a new high? Chances are, the stochastic oscillator Forex indicator does the same. If not, trading strategies derive from it. First of all, being an oscillator, it appears at the bottom of a chart. Any oscillator appears in a separate window at the bottom of a chart.
This tells much about its usability: to spot fake moves the price may make. Second, it has two lines: the main and the signal line. They go hand in hand on that small window below the chart, and all eyes should be on these two lines. The signal one the MetaTrader shows it with the red color is a fast moving average , while the main one is a bit slower.
The default settings show the 5 and 3 periods for the two lines, with the fastest one having the smaller number. While the default scenario uses a simple moving average, any type works: exponential, smoothed, etc. All options work just fine. George Lane, the guy who developed the stochastic indicator Forex traders use, was a smart guy.
He wanted to have an indicator that measures the difference between the actual price and the price range over a period of time. And this is exactly what the stochastic oscillator calculation shows. One thing is important here. The default settings are just default settings. By no means, one cannot change them. However, before doing that, keep in mind the two lines will flatten.
This will make trading signals difficult, if not impossible to spot. Not to mention, irrelevant. If you apply it on a regular chart, it will look exactly like the image below. The usual caveat applies here too: the bigger the time frame, the bigger the implications. Before discussing the actual formula, we should look at what it means.
The indicator travels only in positive territory: between the zero and one hundred levels. This just comes from how the stochastic oscillator parameters work. As mentioned above, its formula considers the main and the signal lines. The actual formula is irrelevant. What matters the most for Forex traders is to know how to read the stochastic oscillator, not the mathematical formula. Now you know why the oscillator comes with the 5 and 3 values as the default ones: the five and the three day-periods make up the formula.
Or a fake move that price might make. Between the price and an oscillator, traders should always trust the oscillator. How come? The answer is straightforward: there are more periods considered, whereas the price shows the current market stance. If one of the two is making a fake move, the price is the one.
Hence, the Forex stochastic oscillator settings for day trading work best when traders use them against the current price. Traders open and close a position based on various things. The most important one is time. To be more exact, the time horizon of a trade gives the type of the trading style used.
Therefore, swing traders consider a few hours or even days for a trade. What they do is they focus on the macro-picture. For investors, it matters most to be fundamentally right, then quick profits. And then there are scalpers. This is where the average Joe, the Forex retail trader fits into. Retail traders start with a huge disadvantage: their own expectations related to trading.
Most of them come to Forex trading for a quick and fast buck. The quicker, the better. The less effort, even better. Or, it may, but is not profitable this way on the long run. Yet, the stochastic oscillator formula is the same for all investors.
The only difference comes from the time frame used. That is, to create an indicator based on a simple formula that helps to spot fake moves. The beauty of this indicator is that all traders can use it. Are you in for a quick buck and scalping suits your personality? Use the stochastic indicator! Is swing trading your thing? How about trying this indicator?
Even investors find tremendous value in it. George Lane wanted multiple things from this oscillator. And, in a way, he did a great job. Any oscillator, in the end, shows overbought and oversold levels. Hence, the first thing to look for is to buy oversold and sell overbought levels. But, an oscillator is more than that. The focus should always stay on it. Because the idea is to find out fake moves for the actual price, traders look for divergences.
To be more exact, divergences between the price and the oscillator. Hence, a great stochastic oscillator strategy is to trade these divergences. Moreover, if the absolute range is between zero and one hundred, can we do something about it?
Is there any stochastic oscillator trading strategy derived from this? The rest of this article deals with three ways that show how to use stochastic oscillator. All of them have one thing in common: they consider the cross between the signal and the main line. As always, keep in mind the time frame. The bigger it is, the bigger the implications for every strategy described below. In Forex trading, overextended refers to overbought or oversold levels.
Therefore, the standard interpretation of an indicator that shows such levels is the following: buy oversold and sell overbought. Moreover, this stochastic oscillator trading strategy uses the current prices. This is important as one can test the relevance of it. The stochastic oscillator indicator shows overbought and oversold levels above or below 80, respectively However, keep in mind what was mentioned earlier: the cross between the two lines matter.
As such, using the Forex stochastic oscillator this way assumes traders should look for a cross in an overbought or oversold territory. More exactly, above 80 or below Since these are the levels, they give the entries. The idea is to sell on a cross above 80 and stay short until the fast line reaches the 20 level.
Stochastics measures the momentum of price. If you visualize a rocket going up in the air — before it can turn down, it must slow down. Momentum always changes direction before price. The Stochastic oscillator uses a scale to measure the degree of change between prices from one closing period to predict the continuation of the current direction trend. The 2 lines are similar to the MACD lines in the sense that one line is faster than the other. The Stochastic technical indicator tells us when the market is overbought or oversold.
The Stochastic is scaled from 0 to When the Stochastic lines are above 80 the red dotted line in the chart above , then it means the market is overbought. When the Stochastic lines are below 20 the blue dotted line , then it means that the market is possibly oversold. As a rule of thumb, we buy when the market is oversold, and we sell when the market is possibly overbought.
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The stochastic indicator is a two-line indicator that can be applied to any chart. It fluctuates between 0 and The indicator shows how the current price. The Stochastic indicator is a tool designed to generate overbought and oversold signals. The indicator consists of two lines. In the settings. Yes, I will always recommend the stochastic oscillator setting (8, 3, 3). It is the best stochastic oscillator setting. Today, we know that if there is a.