Stochastics, like MACD Indicator, are also momentum oscillators, reflecting the strength of market movement, which is helpful for Forex trading.
Stochastics are one of the most important technical indicators for Forex trading.
3 Ways To Use Stochastic Indicator For Forex Trading
Three fundamental ways to use stochastics for FOREX trading:
- Compare the movement of the stochastics to the movement of forex trading prices – If Forex trading prices are making new highs (solidly trending upward) or lows (solidly trending downward) and your stochastics are also making new highs (trending upward) or lows (trending downward) then the market trend will most likely continue.Key Point: if prices and stochastics are in agreement, then currencies are being traded at what the market deems a fair value, and there is no immediate reason to believe that the Forex market will change course.
If, however, prices are making higher highs (trending upwards) while your stochastics are making lower highs then the market is heading toward a reversal (toward a new downtrend). The stochastics, in this case, are saying that the market is overbought, that the currencies are being overvalued. The assumption, then, is that traders will realize that the currency is overvalued and sell, bringing the market into a new downtrend.
It is in this way that stochastics can forecast market corrections – adjustments that the market makes when the price of a currency does not actually reflect its perceived value.
If prices are making lower lows (trending downwards) while your stochastics are making higher lows, then the market is heading toward a reversal (toward a new uptrend). The stochastics, in this case, are saying that the market is oversold, that currencies are undervalued.
The assumption here is that traders will realize that the currency is undervalued and will buy, bringing the market into a new uptrend. Again, stochastics can forecast market movements to correct for undervalued or overvalued currencies.
- The second way to use stochastics is to look at the interaction between the %K and %D lines – If the %K line crosses over the %D line it offers a buy (bullish) signal.If, the %K line crosses below the %D line it offers a sell (bearish) signal. Be careful to not use this stochastic crossover indicator is markets that are in consolidation (moving sideways) because they will not generate reliable signals.
- Stochastics are plotted on a scale of 0 to 100 – The third way to use stochastics to generate useful information about market movement is to look at the movement of the two stochastic lines (%K and %D) across different levels. The levels between 0 and 100 reveal the strength of price movements in one direction or another.
When either stochastic line (%K or %D) is above 80 it’s signaling strong upward price movement in the market. If either stochastic line crosses above 80, then reverses to fall below it, that offers a strong sell signal because it is a sign that the uptrend is reversing. When the stochastic is at 80 or higher but the market is trending downward, that sell signal is called a sell crossover.Conversely, when either stochastic line is below 20 it’s signaling strong downward movement. If either stochastic line crosses below 20, then reverses to rise above it, that offers a strong buy signal because it is a sign that the downtrend is reversing. When the stochastic is at 20 or lower but the market is trending upward, that buy signal is called a buy crossover.
There are two additional trading strategies to consider when trading with stochastics on a 0-100 scale:
- Strategy #1 – a buy 40/40 is a buy signal to trade purely on the momentum of the trend – When the stochastic indicator is at about 50 and trending upward, trade in the direction of the uptrend with a 40-50 pip stop loss and profit limit order.
- Strategy #2 – Conversely, a sell 40/40 is a sell signal to trade purely on the momentum of the trend – When the stochastic indicator is at about 50 and trending downward, trade in the direction of the downtrend with a 40-50 pip stop loss and profit limit order.
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