A stochastic indicator is a complex mathematical calculation used to determine the buying and selling points of investing currencies. A buy signal arises when the indicator moves from below 80% to above 20%. A sell signal occurs when the indicator moves from above 80% to below 20%. A stochastic indicator can be used as part of an overall strategy for deciding when to enter or exit a forex position.
When using stochastic indicators for trading with forex, you should use the currency crosses because they work best. They are ineffective with major currency pairs like EUR/USD and USD/JPY.
A stochastic indicator shows how much momentum the price has to rise (bullish) or fall (bearish). Meaning you can use it to predict reversals in a trend, but it also has other uses. For example, you could use it:
- To decide when to enter a trade
- To set stop-loss levels
- To decide when to take partial profits if your stop loss level has been hit
You must assess whether the current conditions make use of stochastic indicators appropriate. It would be best to have enough volatility to ensure that your entries are correct. You also need to ensure that you follow the current market trend because this indicator is best used in trending markets. You should avoid using it in a rangebound market as stochastic indicators work on breakouts and price movement.
Assess the current market conditions
Make sure the currency crosses you are trading have enough volatility. It would be best to look at a 2-day chart or higher for this information. If the overall trend is up, use stochastic indicators to find trade entries and set stop-loss levels. If the overall trend is down, use stochastic indicators to find sell-entry points and set take-profit levels.
Stochastic indicators work best when combined with other forms of analysis such as support and resistance levels, Fibonacci retracements, Gann angles and candlestick formations.
Use multiple timeframes for entries
It would be best to rely on long-term trends to give your entries direction, but then assess what is happening in shorter timeframes to confirm your entry. For example, you may use a 9-day moving average but wait for stochastic signals on the 1-hour chart. This will give you more accurate information about whether the momentum is with or against your trades.
Use multiple timeframes for taking profits and setting stop losses
It would be best to have enough volatility to ensure that your entries are correct. You also need to ensure that you follow the current market trend because this indicator is best used in trending markets. You should avoid using it in a rangebound market as stochastic indicators work on breakouts and price movement. Be sure to confirm trends using other forms of analysis before placing trades and assessing support and resistance levels, Fibonacci retracements, Gann angles and candlestick formations.
Use the stochastic oscillator to confirm forex signals
Tushar Chande first developed the Stochastic Oscillator to give traders an additional tool for their analysis. It uses the concept of using closing prices to confirm price direction, but it also adds momentum with a 5-day simple moving average of closing prices. Meaning you can see over what period there is buying or selling pressure and use it to confirm potential trade entries. A buy signal arises when the indicator moves from below 0% (oversold) to above 0% (overbought); a sell signal occurs when the indicator moves from above 100% to below 100% (oversold).
Use the stochastic oscillator for stop-losses and take profits
A buy signal arises when the indicator moves from below 0% (oversold) to above 0% (overbought); a sell signal occurs when the indicator moves from above 100% to below 100%. You can use this information together with support and resistance levels, Fibonacci retracements, Gann angles and candlestick formations to make your decision about where to set your stops.
Alternatively, you could wait until a trade entry on one timeframe or another before using Stochastic Oscillator signals as confirmation. A standard method uses mid-price action over short timeframes as a trade entry. It then uses Stochastic Oscillator signals on a lower timeframe in conjunction with support and resistance levels for stop-losses.
Use online forex trading platforms to test these strategies.
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