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Stochastic Oscillator Forex Technical Analysis and Stochastic Oscillator Forex Trading Signals

Developed by George C. Lane

 

The Stochastic Oscillator is a momentum indicator - it shows the relation between the current closing price relative to the high and low range over a given number of n periods. The Oscillator uses a scale of 0-100 to plot its values.

Stochastic Oscillator Technical Indicator


 

This Oscillator is based on the theory that in an uptrend market the price closes near the high of the price range and in a downward trending market the price will close near the low of the price range.

 

The Stochastic Lines are plotted as 2 lines- %K and %D.

  • Fast line %K is the main
  • Slow line %D is the signal

 

3 Types of Stochastics: Fast, Slow and Full

There are 3 types are: fast, slow and full Stochastic. The three indicators look at a given chart period for example the 14-day period, and measures how the price of today’s close compares to the high/low range of the time period that is being used to calculate the stochastic.

 

This oscillator works on the principle that:

  • In an uptrend, price tends to close at the high of the candlestick.
  • In a downtrend, price tends to close at the low of the candlestick.

 

This indicator shows the momentum of the Forex trends, and identifies the times when a market is overbought or oversold.

 

Forex Technical Analysis and Generating Forex Trading Signals

The most common techniques used for technical analysis of Stochastic Oscillators to generate Forex trading signals are crossovers signals, divergence signals and overbought oversold levels. The following are the methods used for generating trade signals

 

Crossover Signals

Buy signal- %K line crosses above the %D line (both lines moving up)

Sell signal- %K line crosses below the %D line (both lines moving down)

 

50-level Crossover:

Buy signal - when stochastic lines cross above 50 a buy signal is generated.

Sell signal - when stochastic lines cross below 50 a sell signal is generated.

 

Divergence Trading

Stochastic is also used to look for divergences between this indicator and the price.

 

This is used to determine potential Forex trend reversal signals.

 

Upward/rising trend reversal- identified by a classic bearish divergence

 

trend reversal- identified by a classic bearish divergence

Trend reversal - identified by a classic bearish divergence


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Downward/descending trend reversal- identified by a classic bullish divergence

trend reversal- identified by a classic bullish divergence

Trend reversal - identified by a classic bullish divergence

 

Overbought/Oversold Levels

Stochastic is mainly used to identify potential overbought and oversold conditions in price movements.

  • Overbought values greater than 70 level - A sell signal occurs when the oscillator rises above 70% and then falls below this level.

Overbought levels Stochastic Oscillator values greater 70

Overbought - Values Greater 70

 

  • Oversold values less than 30 level - a buy signal is generated when the oscillator goes below 30% and then rises above this level.

Oversold levels Stochastic Oscillator values less than 30

Oversold - Values Less Than 30

 

Trades are generated when the Stochastic Oscillator crosses these levels. However, overbought/oversold levels are prone to whipsaws especially when the Forex market is trending upwards or downwards.

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