Forex indicators Stochastic measures closing price of candle on an instrument and compares it to price range of candle in predetermined period. Its goal is to find price retracement which can be a good entry opportunity. This useful tool of technical analysis, was developed by G.Lane and today belongs to one of the most popular forex oscillators (among RSI and CCI).
By default, 5,3,3 is the period mostly used in calculation, however calculation period can be adjusted according to forex chartist needs and time frame he is looking at.
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Anatomy of Stochastic forex indicator
Two lines are drawn in indicator window. %K line and more important %D line.
%K = 100[(Cl – Low5close)/(High5 – Low5)]
%D = 100 X (High3/Low3)
Cl –Last close price
High5- high of five previous closed candles
Low5 –low of five previous closed candles
High3 - high of three previous closed candles
Low3- low of three previous closed candles
In today world there is no need to perform those calculations manually. Proficient trader wishing to use stochastic in his forex trading, should however know stochastics inner workings.
Using the Stochastic indicator
D line is lagging after K line. First sign of price retracement is therefore signalised by changes in K line. Specifically, readings above 70 are overbought, readings under 30 are oversold. Same as with other forex oscillators.
Indicator readings are considered valid, once both K and D lines leave the overbought oversold zones. Stochastic works better in team with other indicators (Moving average, Bollinger bands), or with other tools of technical analysis such as chart or candle patterns.
Stochastic with slower period (21,14,2 and above) can be used to determine trend. Readings above central (50) line are signalising uptrend, while reading below signalise downtrend.
Stochastic is also a sensitive entry tool. By considering both K and D line we can avoid a lot of fake signals. It is also important to wait for them to return from 70/20 zone for signal confirmation.
Two stochastic can be also used in tandem. With slower identifying and confirming trend, while faster determines good price for entry. Once we use Stochastic to determine trend and entry, it is easier to confirm both information by chart analysis (Candle patterns for entry, trendlines drawing for trend).