Stochastic Indicator: 3 New Ways How To Trade Like A PRO

  • One of the most popular indicators
  • There are many strategies based on Stochastic indicator
  • We see two lines in the oscillator by default

What is the Stochastic Indicator?

The Stochastic indicator is a momentum indicator. It is a range-bound (100 and 0 by default) oscillator that shows the location of the close relative to the high-low range over a set number of periods.  

We see two lines in the oscillator. Slow % Kline and a moving average of the same %K that we refer to %D. Stochastic Slowing is usually applied to the indicator’s default setting as a period of 3. This is how the default setting looks like on MT4

How Does Stochastic Indicator Work

Originally developed by George C. Lane in the late 1950s, Stochastic Indicator represents one of the most popular indicators for trading Forex, Stocks and CFDs on indices. Interesting to know is that “stochastic” is a Greek word for random. Stochastic Indicator trading has been very popular between Forex, Indices and CFD traders.

Why Is The Stochastic Indicator Important for Forex Traders?

In this article, we will show you how to trade both intraday and swing. price is preceded by momentum and stochastic usually preemptively signals the entry.

Stochastic Divergence

Understanding Stochastic divergence is very important. Similarly to MACD, When the price is making a lower low, but the Stochastic is making a higher low – we call it bullish divergence. If the Stochastic is making a lower high, but the price is making a higher high – we call it bearish divergence.

stochastic-indicator

Source: NZDUSD Daily chart, Milton markets

Divergence will almost always occur right after a sharp price movement higher or lower. Divergence is just a cue that the price might reverse, and it’s usually confirmed by a trend line break. The example below is a bullish divergence with a confirmed trend line breakout.

Source: NZDUSD Daily chart, Milton markets

This is an example of a bearish divergence with a trend line breakout.

OB/OS Stochastic Zone in Details

Contrary to many scalping and intraday systems that rely on a single stochastic line (usually a faster one – blue line), identifying OB/OS conditions and crossovers is slightly different.

Generally, the zone above 80 indicates an overbought region and the zone below 20 is considered an oversold region. A crossover signal occurs when both stochastic lines cross in the overbought or oversold region

Oversold sell signal is given when the oscillator is above 80 zone, and the blue line crosses the red line while still above 80.

Conversely, an overbought buy signal is given when the oscillator is below the 20 zone, and the blue line crosses the red line while still below 20. 80 and 20 are the most common levels used but can be changed as needed. For OB/OS signals, the stochastic setting of 14,3,3 works pretty well. The higher the time frame, the better, but usually, four h or a Daily chart is the optimum for day/swing traders.

 The advantage of identifying overbought/oversold crossovers is that traders could jump in a trade pretty much early and ride the move from the earliest point. The drawback of this approach is that the price can remain in the OB/OS zone for a long time, making the crossovers futile until the stochastics actually break 80 or 20 zones.

Source: NZDUSD Daily chart, Milton markets

Swing Trading With Stochastic

This strategy uses three indicators applied on the chart: 

  1. SMA (150); red colour but it can be changed to personal preference 
  2. Camarilla Pivot 
  3. Stochastic 6,3,3 with 80/20 levels
  4. RSI set at 3 with 70/30 levels
  5. Timeframe: Daily

This is a swing trading strategy suitable for part-time traders and traders who don’t like to watch the charts very often. We trade it on a daily time frame.

Trade Trigger

Buy: 

  1. Price needs to be above 150 SMA. 
  2. RSI needs to be below 30, or it needs to be crossing 30 from below
  3. Stochastic needs to cross 20 from below
  4. Enter long position

Sell:

  1. Price needs to be below 150 SMA. 
  2. RSI needs to be above 70, or it needs to be crossing 70 from above
  3. Stochastic needs to cross 80 from above
  4. Enter short position

Pro Tip: It is best that the price gets close to SMA before placing an entry. The closest the price is to SMA before an entry, the best r:r will be. 

Targets are pivot points. Traders can also opt to use a trailing stop. For an uptrend, a trailing stop is activated for the first time when Stochastic reaches 80. For a downtrend, a trailing stop is activated when stochastic reaches 20. For starters, traders might move trailing stop in the following way:

  1. For an uptrend, a trailing stop is placed below the previous bar’s lowest price and is moved with each new price bar.
  2. For a downtrend, a trailing stop is placed above the previous bar’s highest price and is moved with each new price bar.

Additionally, traders might move trailing stop themselves.

Stop loss goes above the swing high for shorts and below the swing low for longs.

Sell entry example

Source: NZDUSD Daily chart, Milton markets

Buy Entry Example

Source: NZDUSD Daily chart, Milton markets

What Did We Learn From the Stochastics Article

Keep in mind that stochastic oscillators in Forex trading are often used with RSI, MACD, CCI and even ADX indicators, and the strategies that we use above can also be a unique way to look in the markets. 

The stochastic oscillator works best when it is applied as a standard MT4 indicator that you can find on the MT4 platform as some custom made stochastic indicators may cause slowdowns and even use different stochastic formulas.

Detailed Info on Stochastic Article

What is the Stochastic Indicator formula?

  1. Stochastic indicator is measured using the %K and %D lines
  2. %K = 100 [(C – L14) / (H14 – L14)]
  3. C is the current closing price
  4. L14 is the lowest price when looking back at the 14 previous trading sessions
  5. H14 is the highest price when looking back at the 14 previous trading sessions
  6. %K tracks the most recent market rate for the currency pair
  7. %D = 3 – period simple moving average of %K. It is also called the ‘stochastic slow’ due its slower reactions to market price changes compared to %K.

What is the most common use of the Stochastic Indicator?

We can use the Stochastic for:

  1. Divergence;
  2. Intraday trading;
  3. Scalping;
  4. Buy/Sell confirmation;
  5. Confirmation of Overbought/Oversold;
  6. Daily swing method 

If you want to try other indicators please click here, or If you want to read more articles that I wrote click here.

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