How to Use Stochastic Oscillator in Forex Trading - ForeXposed

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Monday, September 11, 2017

How to Use Stochastic Oscillator in Forex Trading



Stochastic Oscillator consists of two lines called %K and %D. The core of this indicator is %K, while %D is the Simple Moving Average (SMA) of %K. It could be said that %D is the line identifying the direction of %K.

If we look at the Stochastic Oscillator range i.e. 0 – 100, it can be said that this indicator actually does not vary with the Relative Strength Index (RSI). The difference is, in Stochastic Oscillator the calculation includes lowest prices, highest prices, and closing price, at the appointed time.

Well, let's look at the picture below. 
How to Use Stochastic Oscillator in Forex Trading

The above picture is Stochastic Oscillator for GBPUSD with the daily candle periods. It appears that %K tends to be more ‘kinky’ than %D which is smoother than %K curves. One characteristic of these indicators is the movement that is always in 0 – 100 ranges. Additionally, the later you will learn that the Stochastic Oscillator has many variants such as fast and slow.

Now, how this indicator uses? Do the same with RSI? If the same why not simply use RSI? Well, this question is what we will answer this time.

Views of its kind, Stochastic is indeed the same as RSI, it is an indicator of Oscillator types. Usually, the usefulness of this indicator types is indeed to accommodate the movement of buying saturated and selling saturated of currency movements. But there are some things that are not owned by RSI but owned by Stochastic, and likewise vice-versa.

Review to its sensitivity, RSI is far more sensitive than Stochastic. So is ease in reading. RSI has no smoother line %D as on Stochastic. Thus, it can eliminate the bias effects on the reading.

However, the simplicity of RSI can also be a weakness. RSI is less suitable if it uses to know the ongoing trend on the currency. While the combined %K and %D on Stochastic can be a pretty powerful duet in predicting the ongoing trend.

The other thing, Stochastic is not too sensitive as RSI, then the false signal was not so often as on RSI. This is why most traders prefer Stochastic in knowing the saturated buying and selling.

There is some information that we can get with Stochastic Oscillator. But in general, it is no different with information on RSI and SMA. Indeed, Stochastic Oscillator is actually a combination of both types of these indicators, by means of different calculations. Overall, we can use these indicators to determine overbought/oversold state (meaning the prediction of the trend for the long term), the intersection between %K and %D (as a short term trend), and Bullish/Bearish centerline.


Overbought/Oversold

The overbought or oversold conditions according to Stochastic Oscillator retrieved when the %K line has entered 20 and 80 restrictions, i.e. under 20 for oversold, and above 80 for overbought. Same with RSI, isn't it? Please keep in mind, the limitation of 20/80 is not absolute limits. It could be 30/70 or the other. So do not be surprised if I also use a different limitation in determining conditions of overbought/oversold from this situation.

This overbought/oversold conditions will trigger the prices rising and declining in the long term. If the price is increasing but the stochastic is already heading towards its overbought points and started to leave the area, that means will occur a pressure to the price increase rates which ultimately make prices to fall back to its new balance. Look at the following picture. We use 20/80 overbought/oversold restrictions for this time.
How to Use Stochastic Oscillator in Forex Trading

On the picture above, it seems when the prices come into the overbought or oversold area then it will slowly move back down along with the direction of movement of the Stochastic. How many times the Stochastic showed remarkable accuracy in knowing the direction of the next movement (marked with a red circle). By obeying Stochastic alone, it can be seen how big the profit that could be produced within a few days of the movement.


%K and %D Crossing

In addition to the 20/80 area as in the above example, the intersection of %K and % D also can be used to determine the Buy/Sell positions. Occasionally, we run out the patience for waiting for the Stochastic limit to touching 20/80 as we have specified. Although often accurate, not necessarily in the wave motion when Stochastic moving down then he got around to entering the 20 areas, and likewise when it rises. Sometimes, before it got past the area, prices have again moved towards the reverse, so we missed the chance. Well, we can use crossing like Stochastic to determine the Buy/Sell in this conditions.

Just as Moving Average indicator that used by looking at the crossing at two different periods, the same thing also can be applied to Stochastic. The difference here is the crossing that happened was between %K and %D which is smoother for %K.

As we know previously, the %D is the Moving Average (MA) for %K which is nothing but a reflection of the price change. So, in keeping with the nature of MA in determining the trend changes, every intersection between %D and %K, means is a change in the trend for a brief period to the next. A bullish condition occurs when a %K line crossing %D from below, and otherwise, bearish trend occurs when %K crossing from the top. This situation can take place even when the two lines are in the overbought/oversold areas. If this happens, it means that the pressure to buy or sell are very strong, so likely the prices will break through the boundaries of its support and resistance. Consider the following image: 
How to Use Stochastic Oscillator in Forex Trading

Note When %K and %D intersecting each other, and begin to move to the top (marked in yellow) prices also showed an uptrend and keep moving up. Conversely, when the prices move down then the %K and %D also mutually intersect and heading to the bottom. This both conditions is constantly repeated. How to read it is exactly as we interpret the Moving Average indicator.

Well, until here the topics about Stochastic Oscillator. Before we studying about other indicators, I need to remind again about Stochastic Oscillator indicator characters. The advantages and disadvantages of indicators that move in a specified range are its sensitivity Permalink . So also in the Stochastic can be very sensitive when we using it in a period that not appropriate.

Using this indicator with an inappropriate period can take us to the wrong decision-making and ultimately leads us to the great loss in forex trading. Therefore, it is highly recommended that you seek the best periods on these indicators for each of the pairs. The values can be varied. The longest the periods used then the indicator will be more smooth, which means its sensitivity will be reduced. It is also advisable to use Full Stochastic in usage because it is more delicate and can reduce the indicator charts that is too curly.