Stochastics is a commonly used indicator in forex trading analysis. Applied for the first time in the 1950s, Stochastics predict market trends with great precision. Unlike other forex technical indicators, Stochastics are simple to understand and analyze. They can be effectively used by even novice traders to time entry and exit.
Understanding the Stochastics Oscillator
In forex trading, the Stochastics oscillator is used to determine whether a currency is overbought or oversold. Based on this knowledge, a trader can take an investment decision. The indicator consists of two lines - %K and %D. The main oscillating line is %K. It is displayed as a solid line in blue. %D is the dynamic average of %K. It is represented in different tones of red. Both lines oscillate on a 0 to100 scale.
There are three types of Stochastics – slow, fast and full. A fast Stochastics is not highly reliable, as it uses a large range for data analysis. Here, the %K line is not consistent. Slow Stochastics is a derivative of the previous version and uses data pertaining to three periods. It offers a precise analysis of the market trends. Full Stochastics uses both the %K and %D lines for analysis.
How to Use Stochastics in Forex Trading
With Stochastics, you have to follow the upward or downward movement of the two lines. If the lines cross the 80% threshold, the currency is considered to be overbought. Again, if the line dips below the 20% threshold, the currency is seen as oversold. The movement in the middle range (40% to 50%) is considered ideal for buying or selling currencies.
Major indicators drawn from Stochastics are:
If the two lines cross either above 80% or below 20% and move towards the middle region, the trend is expected to continue for a longer period.
A buying signal appears when the lines show consecutive new lows and the corresponding lows are progressively larger. This is called a bullish trend.
The selling signal appears if new highs are found and corresponding highs are progressively lower. This is termed a bearish trend.
While Stochastics is an easy-to-use technical indicator, traders should avoid buying or selling unless the lines cross