Is Stochastic A Good Indicator?

6 months ago forexsimulation 0

It would be best to understand a stochastic indicator if you are looking for a technical indicator with a high degree of accuracy.

Stochastic is a good indicator because it is precise in determining momentum. Besides, you can easily master how to use it. First, you should find out the sole reason for creating the indicator.

Second, you should understand how to calculate and apply it to your forex trading. Lastly, it would help if you differentiated it with the most familiar momentum indicators.

And the best part is that you are about to learn the above points in this no-nonsense stochastic indicator guide. The knowledge will help you boost your profit margins drastically. What is more? Find out below.

What Is the Use of Stochastic Indicators?

Stochastic is one of the best momentum indicators that compares the closing price of a forex currency pair to a range of the currency pair’s prices over a particular duration.

George Lane, who founded a stochastic indicator in the late 1950s, primarily created it to measure bearish or bullish markets. Like Lane, it can help you to foreshadow future reversals.

As a momentum indicator, it measures the rate of price change. The stochastic indicator has a scale ranging between 0 and 100.

The scale enables it to determine a currency pair’s overbuying or overselling. You can deduce its sensitivity by taking the result’s moving average or adjusting the period.

The indicator has two lines; the slow oscillating line marked %K and the %K’s moving average, marked as %D. %K is commonly referred to as the fast indicator, while %D (%K’s 3-period moving average) is the slow indicator.

You were probably wondering where Ks and Ds originated. Here is the thing:

As George Lane and his colleagues attempted to hand-draw various oscillator readings, they frequently ran out of chart paper because of the range of values.

They later realized expressing the values as percentages led to particular stable indicators and named them %K. %K is crucial in calculating and reading stochastic indicators.

Calculating Stochastic Oscillator

Before reading stochastic indicators, you should know how to find their values. Use the stochastic formula to calculate it as follows:

%K =

%K => The current stochastic indicator​’s value

H14 => The highest price traded over the lookback 14 days

C => The current closing price

L14 => The lowest price attained during the past 14-day trading duration

The following are the implications of the above calculations:

How Do You Read A Stochastic Oscillator?

When prices close near the high, it means the market is trending upwards. On the other hand, the closing of prices near the low denotes a downward trending market.

Crossing of %K and %D show transaction signals. You can derive the following strategies from the readings:

Overbuying and Overselling: Overbought region occurs when the readings are above 80, whereas overselling occurs when the readings are below 20.

Crossover Strategy: It shows two signals—first, the sell signal results when %K crosses %D in the overbought region. Secondly, you should buy the currency pair when the %K crosses %D in the oversold territory. 20.

Bulls and Bears: A bullish divergence results when the price shows a lower low while the oscillator records a higher low. A bearish divergence results when prices register higher highs, whereas the stochastic readings show lower highs.

Other strategies to undertake with stochastic oscillators are scalping strategy and day trading.

Comparison Between Stochastic Oscillator and Typical Forex Momentum Indicators

Stochastic Oscillator vs. Relative Strength Index vs. Average Directional Index (ADX)

The critical similarities of Stochastics, RSI, and ADX are that they are all momentum indicators. The technical indicators express values on scales ranging between 0 and 100.

In RSI, a reading below 30 denotes market overselling, while a reading above 70 represents market overbuying. ADX values below 20 represent weak trends and momentums, while those above 50 are strong.

Is RSI or stochastic better? RSI is most applicable in trending markets, whereas stochastics is best for choppy or flat markets.

Conclusion

Stochastic oscillators are crucial if you want to analyze flat or choppy markets quickly. You should know how to calculate and interpret it to use it appropriately.