How to Use the Stochastic Indicator

T

he stochastic indicator, based on the momentum of the price, is used to predict when a price trend is about to end.

Like RSI, here too the values show us when an asset is oversold or overbought. 

Oops, you don’t know about RSI. Don’t tell anyone that we revealed this secret information about our next lesson at the beginning of this one. SHHH! 

To calculate this, the indicator takes a specific price at which it has closed a financial instrument and compares it with its price performance for a given period of time.

The oscillator is based on these two theories:

If there is an uptrend, prices will remain equal to or above the previous closing price.

If there is a downtrend, prices will likely remain equal to or below the previous closing 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.

How to Trade Forex Using the Stochastic Indicator

The Stochastic is scaled from 0 to 100.

Key levels are 20 and 80. 

Levels below 20 suggest that the market is oversold, while levels above 80 indicate an overbought market, the blue and the red dot on our chart, respectively. 

Depending on the strength of the trend, reaching these values does not always mean that a sharp price correction awaits us.

But usually, you need to buy when the market is oversold, and you have to sell when the market is possibly overbought.

Let’s take a look at the chart above.

The indicator is showing us that the overbought conditions are going for a while now.

But where will the price go?

The price will FALL. That is the correct answer, because the overbought remained for such a long time, that it is obvious a reversal will follow this overbought condition.

You should use this indicator mainly for the purpose of showing you whether the market conditions could be possibly overbought or oversold.

REMEMBER: Stochastic indicators can show you overbought or oversold conditions, but they can remain above 80 or below 20 for long periods of time.

Do not hurry to go short, if you see overbought conditions, or buy if you see that the market oversold. 

You need to learn how to adapt the Stochastic to fit your own personal trading style.

Now it is time to move on to the one that slipped off the tongue at the beginning – RSI! 

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