In our last lesson we learned about the Relative Strength Index (RSI) indicator and some of the different ways traders of the stock, futures, and forex markets use this in their trading. In today’s lesson we are going to look at another momentum oscillator which is similar to the RSI and is called the Stochastic.
Let me start by saying that there are 3 different types of stochastic oscillators: the fast, slow, and full stochastic. All of them operate in a similar manner however when most traders refer to trading using the stochastic indicator they are referring to the slow stochastic which is going to be the focus of this lesson.
The basic premise of the stochastic is that prices tend to close in the upper end of their trading range when the financial instrument you are analyzing is in an uptrend and in the lower end of their trading range when the financial instrument that you are analyzing is in a downtrend. When prices close in the upper end of their range in an uptrend this is a sign that the momentum of the trend is strong and vice versa for a downtrend.
The Stochastic Oscillator contains two lines which are plotted below the price chart and are known as the %K and %D lines. Like the RSI, the Stochastic is a banded oscillator so the %K and %D lines fluctuate between zero and 100, and has lines plotted at 20 and 80 which represent the high and low ends of the range.
Example of a Stochastic Oscillator
Whatever charting package you use will calculate the lines for you automatically but you should know that the data points which form the %K line are basically a representation of where the market has closed for each period in relation to the trading range for the 14 periods used in the indicator. In simple terms it is a measure of momentum in the market.
The %D line is very simply a 5 period simple moving average of the %K line. Lastly you should know that you can change the inputs for the indicator and use for example a 3 period moving average of the %K line to get faster signals, however as this is an introduction to the indicator and because most traders I know do not change the standard inputs, I do not recommend changing them at this point.
Like the RSI the first way that traders use the stochastic oscillator is to identify overbought and oversold levels in the market. When the lines that make up the indicator are above 80 this represents a market that is potentially overbought and when they are below 20 this represents a market that is potentially oversold. The developer of the indicator George Lane recommended waiting for the %K line to trade back below or above the 80 or 20 line as this gives a better signal that the momentum in the market is reversing.
Example of Overbought and Oversold Trading Signals
The second way that traders use this indicator to generate signals is by watching for a crossover of the %K line and the %D line. When the faster %K line crosses the slower %D line this is a sign that the market may be heading up and when the %K line crosses below the %D line this is a sign that the market may be heading down. As with the RSI however this strategy results in many false signals so most traders will use this strategy only in conjunction with others for confirmation.
Example of the Stochastic Crossover
The third way that traders will use this indicator is to watch for divergences where the Stochastic trends in the opposite direction of price. As with the RSI this is an indication that the momentum in the market is waning and a reversal may be in the making. For further confirmation many traders will wait for the cross below the 80 or above the 20 line before entering a trade on divergence.
Example of Divergence
As the RSI and Stochastic are similar in nature many traders will use them in conjunction with one another to confirm signals.
That’s our lesson for today. You should now have a good understanding of the Stochastic Oscillator and some of the different ways that traders use this in their trading. In tomorrow’s lesson we are going to look at an indicator which allows us to gauge the volatility of a financial instrument over a given time called Bollinger Bands.
The Global-View Forex Forum is the hub for currency trading on the web. Founded in 1996, it was the original forex forum and is still the place where forex traders around the globe come 24/7 looking for currency trading ideas, breaking forex news, fx trading rumors, fx flows and more. This is where you can find a full suite of forex trading tools, including a complete fx database, forex chart points, live currency rates, and live fx charts. In addition, there is a forex brokers directory where you can compare forex brokers. There is also a forex brokers hotline where you can ask for help choosing a forex broker that meets your individual fx trading needs.
The forex forum is where traders come to discuss the forex market. It is one of the few places where forex traders of all levels of experience, from novice to professionals, interact on the same venue to discuss forex trading. There is also the GVI Forex, which is a private subscription service where professional and experienced currency traders meet in a private forex forum. it is like a virtual forex trading room. This is open to forex traders of all levels of experience to view but only experienced currency tradingprofessionals can post.
Currency trading charts are updated daily using the forex trading ranges posted in the Global-View forex database. You will also find technical indicators on the fx trading charts, e.g. moving averages for currencies such as the EURUSD. This is another forex trading tool provided by Global-View.com.
The forex database can be used to access high, low, close daily forex ranges for key currency pairs, such as the EURUSD, USDJPY, USDCHF, GBPUSD, USDCAD, AUD, NZD and major crosses, including EURJPY, EURGBP, EURCHF, GBPJPY, GBPCHF and CHFJPY. Data for these currency trading pairs dating back to January 1, 1999 can be downloaded to an Excel spreadsheet.
Forex chart points are in a currency trading table that includes; latest fx tradinghigh-low-close range, Bollinger Bands, Fibonacci retracement levels, daily forex pivot points support and resistance levels, average daily forex range, MACD for the different currency trading pairs. You can look on the forex forum for updates when one of the fx trading tools is updated.
Global-View also offers a full fx trading chart gallery that includes fx pairs, such as the EURUSD, commodities, stocks and bonds. In a fx trading world where markets are integrated, the chart gallery is a valuable trading tool. Look for updates on the Forex Forum when the chart gallery is updated.
Global-View.com also offers a forex blog, where articles of interest for currency trading are posted throughout the day. The forex blog articles come from outside sources, including forex brokers research as well as from the professionals at Global-View.com. This forex blog includes the Daily Forex View, Market Chatter and technical forex blog updates. In additional to its real time forex forum, there are also Member Forums available for more in depth forex trading discussions.
WARNING: FOREIGN EXCHANGE TRADING AND INVESTMENT IN DERIVATIVES
CAN BE VERY SPECULATIVE AND MAY RESULT IN LOSSES AS WELL AS PROFITS. FOREIGN
EXCHANGE AND DERIVATIVES TRADING IS NOT SUITABLE FOR MANY MEMBERS OF THE
PUBLIC AND ONLY RISK CAPITAL SHOULD BE APPLIED. THE WEBSITE DOES NOT TAKE
INTO ACCOUNT SPECIAL INVESTMENT GOALS, THE FINANCIAL SITUATION OR SPECIFIC
REQUIREMENTS OF INDIVIDUAL USERS. YOU SHOULD CAREFULLY CONSIDER YOUR FINANCIAL
SITUATION AND CONSULT YOUR FINANCIAL ADVISORS AS TO THE SUITABILITY TO YOUR
SITUATION PRIOR TO MAKING ANY INVESTMENT OR ENTERING INTO ANY TRANSACTIONS.