Ever wondered where trends are been established or reversed? Did you know you could use the stochastic oscillator to your advantage knowing this before it even happens? Yes the stochastic oscillator! No matter the strategy you are implementing in the FOREX market, if combined with the stochastic indicator, it will surely generate you more profits. In this article, we will be taking an in-depth look on what the stochastic oscillator is all about.
Stochastic is a simple momentum oscillator developed by George C. Lane in the late 1950’s. Since the oscillator is over 50 years old, it has stood the test of time, which is a large reason why many traders use it to this day. It is a momentum indicator that shows the location of the close price relative to the high-low range over a set number of periods. According to an interview with Lane, the Stochastic Oscillator “doesn’t follow price, it doesn’t follow volume or anything like that. It only follows the speed or the momentum of price. As a rule, the momentum changes direction before price.” As such, bullish and bearish divergences in the Stochastic Oscillator can be used to speculate reversals in the market. This was the first, and most important, signal that Lane identified.
The Stochastic Oscillator is made up of two moving averages. These moving averages are bound between 0 and 100, where 20 to o represents oversold region and 80-100 represents overbought region.The blue line moving average is the %K line whose response is fast and the red line is the %D line whose response lags. Since %D is a moving average of %K, the red line will also lag or trail the blue line.
HOW TO TRADE REVERSALS WITH THE STOCHASTIC
Trading reversals at extreme levels is the key here. When the 2 moving average gets to the overbought region, we will be waiting for crossovers of the moving averages to the downside to open sell orders. This indicates a potential shifting trend lower from overbought levels. We can also apply chart pattern and price formations like engulf pattern or pin bars for confirmation of the reversal.
This methodology also applies to oversold regions. Likewise, a cross up that occurs below 20 would indicate a potential shifting trend higher from oversold levels. We can also imbibe the use of resistance or support and supply or demand to pick reversal signals in these zones. The diagram below represents a trading opportunity that presented itself in the USD/CAD currency pair in the weekly central pivot, the stochastic oscillator shows that the market has been overbought which made price to fall.
HOW TO TRADE TREND CONTINUATION USING THE STOCHASTIC
Believe me this is the most interesting part of this indicator. You see when it comes to trend trading you cant overrule the stochastic oscillator. Over the years i discovered that most trends are been established within the range of 76 and 90 region for buy trends or 24 and 10 region for sell trends. This is just like applying the indicator in the opposite way we were taught to use it as we both know the default purpose of the indicator is to pick swing trades (buying bottoms at oversold region and selling tops at overbought regions).
However we all know that in FOREX trading, there’s nothing as rewarding as trading along with the trend as they say “the trend is your friend”. So in this case we will only be picking trades when the stochastic is synchronized with the major trend in the 76 to 90 levels for buy trades and also 24 to 16 for sell trades. A diagram below illustrates a trade signal for buying in the USD/CAD currency pair.
TIMING IS THE KEY
Timing is an essential ingredient when it comes to trading the FOREX market. Though the market moves round the clock but we have to know the period the market will mostly make its tremendous move as the market ranges time to time. From research, it is best known that the Euro/London open session and New York session is the best time to trade the FOREX market. This is because it has more liquidity and volatility so it provides more profitable trading opportunities. However to increase performance, the first 2 hours of the sessions is the best time to trade. The Euro/London opens from 8am/9pm GMT and New York session opens 2pm GMT.