All forex brokers offer some trend indicators as well as oscillators with the default settings when opening an account. Stochastics is always there, and this makes it an important indicator to consider when looking at forecasting future price movements.
Using the Metatrader, the oscillator is quite easy to be found, as one only needs to go to the Insert tab, chose Indicators, then Oscillators, and the Stochastic is going to be found listed there.
The beauty of Stochastics rests in its simplicity, as it is basically showing an intersection of two lines that is supposed to happen within either the overbought or oversold levels.
The values are always positive in the sense that the oscillator is traveling from 0 to 100, and anything below the 20 level is considered to be oversold, while any move above the 80 level is considered to be overbought.
Those levels are the levels to be watched for a cross by the time the oscillator travels there.
Coming back to the default settings, one can choose what kind of MA (Moving Average) the Stochastic should use. The default one is the simple MA, but the exponential one can be as easily used as well. I would say that both of them are offering pretty good results.
The rest of the settings, namely the K and D lines, are better to be left as they are being provided. In case values are being changed, the oscillator will find it difficult to reach overbought and oversold levels if the initial values are being changed with higher ones.
If you plot the indicator on any chart, the result will look like the image below.
There are multiple ways to use this oscillator and the most popular one is to look for a cross between the two moving averages for a signal to trade in the other direction. If looking for a cross to offer the entry into a trade, it should be mentioned that the cross must happen in the overbought or oversold territory, usually above 80 or below 20.
This way the trader is always knowing when the market is possible to make a turn and adjust his/her positioning accordingly.
However, there is a catch; this way of trading is very accurate and offers stunning results only when market is ranging. In other words, it is advisable to use it when ranges are expected, like:
– in a Non-Farm Payrolls week or in the first three days of the week. It is known that NFP weeks are usually ranging ones when it comes to the US dollar pairs as no one is really taking a chance ahead of the important release on Friday.
– in the Asian sessions. Asian sessions are characterized by small ranges holding and rarely things are moving. Therefore, avoiding red events on the economic calendar that are happening on the Asian session, this strategy brings spectacular returns.
But is there a way to trade with the Stochastics when market is not ranging? Or trending? The answer is yes, and there are at least two possibilities to do that:
– the first one is to look for a bullish or a bearish divergence. After all, Stochastics is an oscillator and a divergence between price and oscillator is always leading to the trader trusting the oscillator rather than price. The example below shows a bearish divergence forming between price and oscillator right before the Brexit vote for the United Kingdom to leave the European Union. It was a warning that market is positioning on the long side of the US dollar as this bearish divergence between price and Stochastics told earlier the actual trading direction.
– Another way to successfully trade with Stochastics is to use the indicator as a continuation pattern. This is a very good strategy but it is more efficient when scalping (taking trades for small targets, entry and exit being quite fast). The way to go is to split the distance between 0 and 100 (the maximum levels of the oscillator) and therefore to add the 50 line on the oscillator’s window. It is an easy way to profit from Stochastics, but again, having small to very small targets.
The same strategy can be used on bigger time frames as well, only that the bigger the time frame, the bigger the target should be.
To sum up, Stochastics is an oscillator everyone should take into account and, at the same time, it is just another oscillator. The fact that it is so visible though, namely the cross between the two lines, is a clear signal to trade the other way, making this very popular among traders.
The next article in the beginner’s category is going to address an important aspect to Elliott Waves theory: how to calculate the extended wave in an impulsive move.