Stochastics with Forex

Trading Forex with Stochastics Indicators (www.mo4forex.com’s Forex Notes)

I remember Stochastics from when I dabbled in trading stocks a few years back. I didn’t quite grasp the importance of Stochastics back then but I now realize they are one of the most helpful technical indicators in finding which direction the Forex market will go. I do believe I used them incorrectly when I first started out trading back then, but this time I was determined to use Stochastics to my advantage, so I sought out in depth explanations and modifications to this indicator. The stochastic indicator is a momentum oscillator, which can often indicate a pair’s upcoming strength or weakness in advance of a reversal.

What Stochastics does is calculate the current close price relative to the high/low range over a period of time that you can set and displays this result in the form of 2 lines. The %K line Is the main line and is usually displayed as a solid line. The %D line is a moving average of the %K and is displayed as a dotted line here.  In the example to the right it’s in the bottom window, it’s the real wavy looking lines in red and blue.  If we compare price movements with stochastics, there’s always movements up and down, but its those big moves we want to try and catch, which is why I’ll explain below, I’ve learned you can’t just trade using this one indicator if you want better odds.

· %K line is more sensitive than %D
· %D line is a moving average of %K
· %D line gives the trading signals

The three types of stochastics are Full stochastics fast stochastics and slow stochastics.
Slow stochastics is a smoother version of fast stochastics.
Full stochastics are even a smother version of slow stochastics.

How To Read Stochastics:

Buy when %K falls below the oversold level (below 20) and rises back above the same level.

Sell when %K rises above de overbought level (above 80) and falls back below the same level.

Many experts will say reading stochastics and applying them to Forex trading, only works when the market is flat or ranging. Understandibly, in a strong uptrend or downtrend, a reading on Stochastics might not always result in tren reversals, simply because a strong uptrend will always have retracements at some point, and reading Stochastics literally on each wave up or below the overbought/oversold levels can only be indicitave of a temporary movement. It’s important to note when the market is an uptrend then Buy Signals will always have greater probability for wins. The opposite is true in a downward trending market, we’ll want to find opportunities to sell instead of buy. ALthough counter trend trading on a longer time frame is profitable for many people.

The chart below is an example of what I’ve been taught to look out for, multiple indicators of a possible reversal in trend. Here I could have tried a coulpe of things, but keeping to the Stochastics aspect, we see that the %K line flip and rise above the 80 level (#1 Indicator), simultaneously we see the top of the trend channel be tested (#2 Indicator). Now, if I just jumped right into a counter trend trade, I’d experience a few pips in drawdown AND possibly get scared out of the trade when that retracement that breaks the channel line. RSI also indicates the pair is overbought (#3 Indicator) and if I had drawn a tren line in this move up, it wouldn’t have been broken until that second little move up is over, indicating a safer place to enter (#4 Indicator). So with all of these indications the price might reverse, I still did not enter this trade, to my own detriment, simply because I am scared out of counter trend trading by alot of people who have failed miserably at it. Including myself. But when I (you) take the time to sit down and analyze the charts for multiple indicators, we can ultimately become better traders on our own terms.

On the other hand, we could always trade with the trend, in which case we’d look for places this pair is oversold, this is when the stochastics fall below the oversold level [the red line in the chart above] and returns near to the same level.

When the market is trending down we will only look for overbought conditions (when the stochastics rise above de overbought level [above 80] and falls back below the same level. This isn’t rocket science once you see it take place a few thousand times