Using the Stochastic Oscillator the Right Way
If you are just getting into the world of Forex trading, then there are quite a few important things that you need to know. Now, when it comes to being able to find the best possible trades, what you need to know all about are indicators. What we are here to talk about today is the Stochastic indicator, otherwise known as the stochastic oscillator.
When it comes down to it, this stochastic indicator is hands down on the best indicators that you can use. This indicator can actually be used in multiple ways. Now, the problem with the stochastic oscillator is that many people just don’t know how to use it. Today, we are here to help solve this problem.
What we are here to do today is to take a closer look at one of Andrew’s most popular trading guides on Andrew’s Trading Channel. Today’s article is going to feature a combination of stochastic oscillator tips that Andrew provides in his video, as well as some of the most basic and important info that you need to know about it. Let’s get right to it and explain what the stochastic oscillator is, and how to use it the right way.
What is the Stochastic Indicator?
First and foremost, the stochastic indicator is a type of momentum indicator. In other words, this indicator provides you with valuable information about the strength of a certain trend. This is a type of indicator that was first developed in the 1950s by a man named George Lane.
Technically speaking, this indicator measures the relationship between an asset’s closing price and its price range over a specific period of time. The fact of the matter is that to this day, the stochastic oscillator is by far one of the most popular momentum indicators out there.
The reason for this is because it is very easy to read and to use, plus it is also very accurate in terms of indicating whether you should place a buy trade or a sell trade. Therefore, it is in part also a trend indicator, because after all, if an indicator tells you how strong a trend is, then it also tells you whether or not there is a trend in the first place.
What Does it Tell You?
Let’s provide you with some more detailed information on how exactly this stochastic oscillator works and what it tells you. One of the most important things to note here is that this indicator is range bound. The value it will show you is always going to be between 0 and 100. One of the best things about it is that it is ideal for telling you if a security is overbought or oversold.
Generally speaking, if the reading is at 80 or over, it indicates that something is overbought. If the stochastic indicator provides you with a value of 20 or below, it indicates that a security is oversold. Although this is a good indication of the momentum of a trend, it’s not always 100%. Securities can sometimes remain overbought or oversold, while also continuing with the same trend.
Another big benefit of this particular indicator is that it is much easier to see hidden divergences with it than with most other indicators. The other important thing to know here is that charting the stochastic oscillator usually consists of two lines. One line is the realtime value of the oscillator, while the second line represents the three day simple moving average. Now, the most important thing to know is that when these two lines cross, it signals that there is a trend reversal on the horizon.
Calculating the Stochastic Oscillator
Something else that you need to know in order to actually put this indicator to use, is how to calculate it. The formula for this indicator is as follows.
Here, C represents the most recent closing price, L14 represents the lowest trading price in the last 14 days, H14 represents the highest price traded at over the last 14 days, and %K represents the current value of the stochastic indicator.
The stochastic oscillator does have a couple of drawbacks that you certainly need to know about, so let’s take a quick look at these.
One of the drawbacks here is that it may sometimes produce false signals. In other words, it may tell you that there is a reversal on the horizon, when this is actually not the case at all, which can therefore lead to a losing trade. If a market is very volatile, the chances of this occurring are fairly high.
In order to combat this issue, one good thing that you can do is to use the price trend as a filter. In other words, if signals from your stochastic oscillator go in the same direction as a trend, then it is generally a safe trade. Also keep in mind that this indicator is not the best to use in a sideways trending market.
Tips for Success When Using the Stochastic Oscillator
Right now, we want to finish things off by providing you with some of the most important tips for success to follow when trading with the Stochastic oscillator.
- When trading with the stochastic oscillator, one of the most important things to keep in mind is that if you use lower settings, it will generally provide you with more signals.
- The next most important tip to follow here is that when using the stochastic indicator on your chart, the best settings to use are usually the default settings, which are 14, 3, and 3.
- What you also need to realize here is that if the market is trending strongly, you really want to use a pattern trading strategy for the best chances of success.
Using the Stochastic Indicator – Final Thoughts
When all has been said and done, we definitely recommend watching full video that Andrew has uploaded about the correct way to use the stochastic indicator. The bottom line is that this is an excellent momentum indicator that you should absolutely master.
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