We will now meet you with another indicator, which is a member of the Oscillator Family. This is the well known Stochastic Oscillator indicator.
Since it is an oscillator, this means that the Stochastic is a leading indicator, which gives the signals before they have actually occurred. This usually puts you in the market early in the trend, which is great! However, the signal success rate of the Stochastic is relatively low, as with every other oscillator. This is how the Stochastic Oscillator Forex indicator will look like attached to the bottom of your chart:
Structure of the Stochastic Oscillator Indicator
The Stochastic consists of couple lines, which fluctuate in three areas. These are an overbought, oversold, and a middle (neutral area).
One of the lines is faster than the other. This way the Stochastic constantly shows crossovers, which are used as bullish and bearish signals, depending on the direction of the cross. Let’s now meet all these signals!
Stochastic Oscillator Indicator Signals
There are four basic signals when trading with the Stochastic Oscillator software. We will now approach each of these!
Stochastic Lines Crossover
Since one of the lines is faster than the other, it constantly breaks it upwards and downwards. This is how the Stochastic crossover is created. When the two lines cross, we get a signal in the direction of the crossover.
Overbought Stochastic Oscillator
The Stochastic is overbought when the two lines are located in the upper zone. When this happens, traders wait for a bearish Stochastic lines crossover, followed by a bearish exit from the overbought zone. This is the ultimate short signal from the Stochastic indicator.
Oversold Stochastic Oscillator
The Stochastic Oscillator is oversold when the two lines are in the lower zone. If this appears on the chart, traders hunt for a bullish Stochastic crossover, followed by a bullish exit from the oversold zone. This set of events creates the ultimate long signal from the Stochastic.
Divergence of the Stochastic Oscillator Indicator
The Stochastic divergence works as with any other trading indicator. You get a bullish divergence between the Stochastic and price action, when price is dropping and the Stochastic Oscillator is increasing. Contrary to this, you have a bearish divergence between the indicator and the price action, when the Forex pair is increasing, while the Stochastic is decreasing.
Bullish divergences imply about potential rapid price jumps upwards. Bearish divergences on the other hand hint about upcoming rapid price drops.
Stochastic Oscillator Indicator Trading
Now you know the structure of this trading indicator. For this reason we will switch to the more serious part of this lesson – trading with the Stochastic Oscillator Indicator. We will show you a real chart example, which illustrates Stochastic signals on the graph. Have a look at the image below:
The image above illustrates the basic Stochastic Oscillator Strategy.
The green red circles on the image above indicate overbought stochastic signals. Notice that every time we get this signal the price records a decrease.
The green circles on the chart point out to oversold signals on the chart. When we get this signal the price increases.
The blue lines on the chart indicate a bullish divergence between price action and the Stochastic Indicator. After the divergence the price increases.
As you see on the image above, the Stochastic Oscillator gives many signals. Each of these signals has the potential to put you in a trade. However, since the signals anticipate the real event on the chart, the Stochastic Indicator success rate is relatively low. Therefore, you should always combine this indicator with an additional trading tool. The reason for this is that the Stochastic is not a good standalone trading indicator.
Click on the button below and start right away!