The stochastic is simply one of the best tools for better market timing you can use. It's extremely simple to Understand, apply and make big profits with. Here we will look at one of its best uses - trading crossovers from over bought or oversold levels.
First let's look at the logic upon which the stochastic is based.
The Calculation
Before we look at the calculation don't worry if you find it a bit confusing - this is a very visual indicator and just like you don't need to know how an internal combustion engine works to drive a car, you don't need to know the mathematics of the stochastic to use it effectively.
The stochastic was developed by Dr. George Lane and is two lines called %K, a fast line and %D, a slow line.
%K line is a more sensitive line than %D
%D line is a moving average of %K
The %D line acts as the trigger and gives the trading signals
The plotting of the stochastic is very similar to the plotting of moving average lines.
For example, you can think of the %K as a fast moving average, and %D as the slower moving average.
The lines are plotted on a scale of 1 to 100
The 80% value is normally used as overbought warning, while the 20% is used as an oversold warning. Once the lines get into these areas and the more they rise or fall above or below these levels the greater the chance of a reversal.
We tend to look for trading opportunities when the stochastic is above 90% and below 10% and look for crossovers from these levels.
Let's look at crossovers in these overbought and oversold areas to trigger trading signals. You would essentially look for the following - buy when the %K line moves above the %D line, and sell when the %K line moves below the %D line.
Beware of short-term crossovers that may generate unreliable signals on your forex charts.
The best crossover trading signal is when the %K line intersects, "after" the intermediate top of the %D line and is referred to as a right hand crossover.
The stochastic if used in conjunction with support and resistance is very effective and if you learn to trade stochastic crossovers from chart extremes you will be catching some great contrary moves.
The stochastic has other uses but the crossover is our particular favorite. You can learn to use the stochastic in about 15 minutes.
Most major chart services plot it and with a little practice you will be timing your trading signals with greater accuracy, improving your market timing and that means bigger bottom line FX Profits.
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