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Lesson 10 – Stochastics
Written on 10 November 2008 by Staff
The Stochastics is an oscillating indicator that was developed by George Lane in the early 1960’s.
The Stochastic is a momentum oscillator that oscillates between 0 and 100 and consists of two lines: Percentage of K an Percentage of D.
%K is the main line and is usually displayed as a solid line on the trading platforms.
%D is simply a moving average of the %K and is usually displayed as a dotted line on trading platforms.
There are three types of Stochastics: Full, fast and slow Stochastics. Slow Stochastics are simply a smoother version of the fast Stochastics, and full Stochastics are even a smoother version of the slow Stochastics.
There are three basic ways to use Stochastics for trading the Forex Market:
1- Overbought / Oversold
2- Crossover
3- Divergence
1- Overbought / Oversold:
When one of the stochastic lines reaches and crosses above the 80% level, it means it is in an overbought market.
When one of the stochastic lines reaches and crosses below the 20% level, it means it is in an oversold market.
The common practice is to Buy when the stochastic falls below 20% level then rises above it.
And in the same way, sell when the stochastic rises above 80% level and then falls back below it.
2- Crossover:
We can treat the %K and %D lines of the stochastic indicator as if it where two moving averages, where there is a slow moving average and another fast moving average. So with this said, we are looking for the crossover of these two moving averages to take a short or long position.
Buy when the %K crosses above the %D.
Sell when the %K crosses below the %D.
Once again, the crossover of the stochastic line often provides choppy signals that need to be filtered with other indicators.
3- Divergence:
Divergences may also occur in the same way they occur with other oscillating indicators. These may provide a more solid signal for Buying or Selling currencies.
For example, if prices are making a series of new highs and the stochastic is trending lower, you may have a warning signal of weakness in the market.
