The Stochastic Indicator is a favorite among newer traders because it is one of the first tools that they are taught how to use, and because it is so easy to understand. People really appreciate it when some of the complexity of the markets is boiled down into somewhat simpler terms.
The End Of A Trend
Determining when a trend is ending is something that traders attempt to do all the time. They are looking for confirmation that the assumptions they have made about the markets are correct, and that is why they are always looking to use indicators such as the Stochastic to try to figure out when that trend is coming to a close.
How to Trade Using the Stochastic Indicator
When the Stochastic is trending above 80 (above the top line on the chart above), it is trying to tell a trader that the currency pair is overbought. This is an indicator that it might be time to SELL.
When it is below 20 (below the bottom line on the chart above), it is trying to let that trader know that the pair may be oversold. This is an indicator that it might be time to BUY.
Traders should know that the Stochastic can stay above 80 or below 20 for long periods of time, so just because the indicator says “overbought” doesn’t mean you should sell with reckless abandon.
Combine With Other Indicators
There are reasons to combine the Stochastic with other tools that you have at your disposal, and you should attempt to do so frequently. The Stochastic is a very simple tool, and that is great for getting a reading from it, but it doesn’t always translate to a tool that is incredibly accurate.
Some research has shown that relying on the Stochastic all by itself is likely a mistake because there are too many variables that come into play when trading this. You may want to reconsider your approach in that you can potentially find better outcomes when you use other indicators instead.
The Stochastic should simply be your starting point for seeing when a pair is overbought or oversold. You shouldn’t stop there. You should always check it against other indicators that may give you a more complete picture of what is happening.
Think of the Stochastic as your early warning system to let you know that there is something interesting going on with a currency pair, but use other indicators such as the RSI, the MACD, and even Fibonacci retracement levels to really figure out what is going on.
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