The Stochastic indicator is one of the default installed in trading terminals of traders around the world. This is not only Metatrader 4, the instructions for using which you can find here, but also other popular trading platforms and online charts. In this article, we will analyze this wonderful indicator “by the bones” and select its settings, learn the history of its creation and study its practical use.
The author of the indicator is George Lane, invented the stochastic in 1950. Moreover, initially, as was the case with many now gurus of financial markets, he did not plan to connect his life with the stock exchange at all. He was going to follow in his father’s footsteps and become a doctor, but one day, having tried to trade on the stock exchange, he realized that this was his true vocation – to become a trader.
George Lane’s observations were that he identified a certain pattern in the market: the price does not constantly move in a trend, but makes back-and-forth fluctuations. So he came up with the idea to create an indicator that would capture this dynamics and show when the price should make a particular move.
By the way, stochastic belongs to the class of oscillator indicators, and this word comes from lat. oscillo – to swing, to oscillate… And the concept stochastic means – having an element of randomness, just like the price in the market. Thus, the Stochastic Oscillator can be called roughly as an indicator of probable price fluctuations.
Much time has passed since then, but the stochastic is still widely used by traders around the world in a variety of trading strategies. It has proven its worth over time.
Indicator formula (not necessary to know, but for general development):
Explanation of the formula:
- С – the closing price of the current period,
- Ln – the minimum price (low) for n periods,
- Нn – the maximum price (high) for n periods,
- n – the number of periods, selected in the settings,
- % D (set in the indicator settings) is a moving average of% K
On the chart, the stochastic is displayed “in the basement” and consists of two main lines:
The solid line is the% K stochastic value itself, which was calculated by the formula, and the dotted line is the% D, which is set in the settings.
There is a separate detailed article about all the settings, I highly recommend reading, because we disassemble the indicator “by the bones” and work out all the nuances so that you do not trade blindly, but do everything consciously, like professionals. So, in order not to completely repeat myself, I recommend reading the article provided. There we also considered the issues of setting for different timeframes and other points.
How to use the stochastic indicator
To trade stochastics, you need to understand what signals the indicator is capable of giving, there are only three of them.
Overbought and oversold zones
These are areas in the indicator window, and we also have a separate detailed article about trading them. Here I will mention in a shorter version what it is.
- Overbought indicates that the price is too high at the moment and should be expected to fall. This means you can start looking at selling opportunities and you shouldn’t buy.
- Oversold means that the price is too low and should be expected to rise. Accordingly, we look for buying opportunities and do not sell.
- The neutral zone does not give signals.
Details are in the article at the link above. I deliberately do not give all the information in one post, so it will be difficult to assimilate and the post will turn out to be very long. So be sure to click on the links to the detailed materials that I give.
Convergence and divergence of stochastics
Translated into simple language, this means convergence and divergence. Believe it or not, we also have a separate, detailed and very good article about this.
Sometimes it happens that the price shows new highs on the chart, while the Stochastic waves, on the contrary, begin to decline.
The opposite is also true when the price draws lows and the indicator rises. These are convergence and divergence. They are considered a very strong signal in technical analysis and indicate an impending price reversal. It is very important to take these signals into account when working on Forex, so I highly recommend reading a detailed article on convergence-divergence!
Intersection of stochastic lines
This refers to the dotted and solid lines. It is considered a buy signal when:
- Both lines are in the oversold zone
- Solid line crossed the dotted line from bottom to top
A sell signal occurs when:
- Both lines are in the overbought zone
- Solid crossed dotted top-to-bottom
The stochastic indicator must be learned to understand and use in your trading. It is one of the most popular indicators in the world and underlies many trading strategies and systems. With the help of our site, you can do this with ease, but it is necessary, firstly, to read this article (you have already read it), and secondly, read the detailed articles mentioned above.
So you will receive structured knowledge about all aspects of stochastic trading and this knowledge will help you in mastering other oscillators, since they work on a very similar principle. We are talking about indicators such as MACD, RVI, RSI and others. So you’re making a big step in learning tech analysis if you follow this advice.
And to make it interesting for you, all materials are written in a simple and understandable language and many are provided with video tutorials. And if something is not clear – ask questions in the comments and see you soon on the pages of our Forex portal!