Stochastic is one of the older technical indicators. Its been around for more than 50 years. It was created by George C. Lane so he could measure momentum by looking at how strong or weak the current close is compared to the previous high/low for X amount of bars.
When price consistently closes at the high end of the bar then the Stochastic Technical Indicator will rise. This means we are seeing buying momentum. The opposite is true for selling momentum. George Lane used a settings of 14 period called %K with a 3 MA to smooth it out.
Additional to this a trigger line of the smoothed %K is added to give the buy and sell signals. The trigger line which is called %D is just a normal 3 MA. This gives two lines on the chart. The smoothed %K and %D. Your charts will state 14,3,3 as this is the settings but you can change to match your trading style.
Are you scalper? If yes, then you might find better use in a setting of for example 7,3,3. When the Stochastic line (%K) is above the trigger line (%D) then the momentum is bullish for that short period of time. When the Stochastic line is below the trigger line then it is bearish momentum.
George Lane’s original entry signal is when the Stochastic line crosses the trigger line on a close. This means the price bar has to close for a valid signal. George Lane added two levels to the Stochastic which was 80 and 20. If Stochastic is above 80 price is overbought and if Stochastic is below 20 price is oversold.
People not really familiar with Stochastic believe that the overbought and oversold are the main purpose of the Stochastic indicator but this is not entirely true. George Lane saw that price could stay overbought or oversold for a long time so he only uses these levels to take the best signals that the crossovers give.
So when looking for long entries Stochastic has to have been below 20 for an oversold scenario. This is because the best move happens after an extreme in price. You now know how George Lane used this Stochastic indicator but many traders today add other indicators or methods to increase their odds of success.
1) Trend Stochastic is a short term indicator, meaning it does not take anything into consideration beyond your settings of %K. In this example the 14 period. That is a relative short history. So many traders add a longer term MA to determine the trend of the bigger picture and then only trade with that trend. So if the trend is up then they ignore the sell signals triggered by the Stochastic. Stochastic Trend
2) Stochastic Divergence Beside using trend as a filter many traders uses divergence. So for example before going long you want to see divergence where price makes a lower low but Stochastic makes a higher low. This means the lower low in price was not confirmed by the indicator.
That’s it on my Forex technical indicators section I hope that you have enjoyed running through all different indicators and learning more about how they work and how you can use them in your trading. If you have a particular Technical indicator that is not featured in then technical indicator section please contact me and I will do my best to add it to this section for you. Remember, don’t miss out on the other parts of the website where you can get some great forex tips, tricks and weekly updates so remember to keep coming back regular to make sure you have not missed anything!