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How to use stochastics when trading forex?

How to use stochastics when trading forex?

A stochastic oscillator is a momentum indicator that helps traders identify overbought, oversold and trending markets. The red line represents the stochastic %K of the instrument in the stochastic indicator. It shows where price closed relative to its range during a specific period.

 

The Stochastic Oscillator was created by George Lane based on observations he made while studying charting techniques among several speculators who traded futures.

 

Later this indicator became famous thanks to Dr George C. Lane’s book “New Trading Dimensions”. Initially used as a momentum oscillator, it gives market entry points according to specific rules.

How to use stochastics when trading forex

Using this indicator for currency trading purposes has several advantages compared with other indicators.

 

First of all, it is easy to understand its components, although stochastic doesn’t provide specific entry points for entering into trades, unlike other more complex indicators.

 

The fact that it represents where the price closes relative to previous prices gives traders an idea about current market conditions and trend changes to take advantage of them.

 

It should be noted that stochastics require an M5 timeframe or higher on currency pairs, so don’t try using a ticker because you will probably get wrong signals which can cost money if you didn’t read this article properly.

 

Before discussing how to use stochastics, one should get familiar with this indicator’s parameters to determine the levels of overbought and oversold market conditions- something which is essential when trading currencies.

 

The stochastic oscillator uses ‘overbought’ and ‘oversold’ keywords in its formulas, so it’s essential to know when these two conditions can be found on indicators [price action based analysis is recommended when looking for such signals].

 

It shall be noted that when this technical tool is used together with other indicators, getting correct entry points becomes much easier; however, there’s no assurance that you will enter into trades before price reverses.

 

Nevertheless, additional confirmation will reduce possible losing trades compared to using stochastics alone.

 

Another point that can differentiate between trading success and failure is knowing how to use this indicator, keeping in mind the chart’s timeframe you are looking at.

 

It would help if you never used a lower timeframe than M5 because stochastics doesn’t have enough information for producing reliable signals on ticker [M1-M15].

 

For those who trade on higher time frames, it’s recommendable using daily or weekly charts as possible so that selling opportunities could be found more efficiently and short-term overbought conditions.

 

So now, let’s discuss entry points for taking trades based upon stochastics’ signals as outlined below.

 

  1. Price breakthrough the 80 levels if the price was rising before making this signal, it means that market is becoming more overbought at daily timeframes and might be reversing soon.

 

You can adopt the same strategy but in the opposite order, if trendline was broken on the lower timeframe and stochastic signals move into the oversold zone- entry point is when resistance confirms such movement

 

  1. Piercing of 20/80 levels from below. If momentum was pointing upwards and prices pierce 20 levels downwards, it’s a clear sign they are becoming even more underbought, so there’s a good chance for short term reversal

 

If stochastic was pointing downwards and prices pierce 80 levels upwards, it’s a clear sign they are becoming oversold, so there’s a good chance for short term reversal

 

  1. When price breaks the Stochastic line on the daily timeframe. It means the market is becoming more underbought at daily timeframes and might be reversing soon.

 

You can adopt the same strategy but in the opposite order, if trendline was broken on the lower timeframe and stochastic signals move into the oversold zone- entry point is when resistance confirms such movement

 

  1. Divergence between prices and stochastics. Some traders might be aware of this already because it’s often a divergence indicator in many trading books, forex training courses and blogs.

 

However, the problem is that not everyone knows what to do with such a signal or, even worse, doesn’t pay attention, which means losses for those who don’t know how to use this technical tool properly.

 

 

 

 

 

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