If you are serious about currency trading, you should familiarize yourself with the Stochastics indicator. This indicator is also called an oscillator, because the price movement is banded in between two extreme values. What makes Stochastics popular among critics is that they are easy to use and understand, as well as being adjustable enough to give you the kind of trading signals that you want. The Stochastics indicator consists of two lines, the %K line and the %D line. The %K line is the actual Stochastics line and the %D line acts as a signal line.
Stochastics are generally divided into fast, slow and full, with the slow Stochastics being the most generally used oscillator among the majority of traders because of the strong signals it generates. The best way for you to understand the differences between them is to look at graphs of the two types of Stochastics. While the two graphs show the same basic pattern, you can see that the fast Stochastics has more volatility since the line goes up and down more frequently. Because of this, scalpers who prefer to make a series of short-term trades prefer using a fast Stochastics indicator, since there are more trading signals.
There are three ways you can trade with signals from a Stochastics indicator:
- When the %K line crosses the %D line, a trading signal is generated. When the %K line crosses in an upward direction, it indicates that the market is bullish and the price is about to go up. On the other hand, if the %K line crosses in a downward direction, the market is bearish and the price is about to go down. However, there is a risk of so-called whipsaw action in the trading signals, in which the price seems to be heading in one direction, but then abruptly moves in the opposite direction. Whipsaw patterns can move either upward or downward.
- When the Stochastic Oscillator moves in a different direction from the price, an indicator that is also known as Divergence. For example, if you see the price moving downward, and then the oscillator moves upward, then it may be a trading signal that the price is about to change direction. However, the trader may have to exercise patience since the change may take weeks to happen. This is also one of the rarer trading signals.
- When the Stochastic Oscillator moves above the 80 level or moves below the 20 level. If this happens then the currency may be overbought or oversold. When the Stochastics indicator falls below 20 or 30, there may be a good opportunity to buy a currency pair since the price may be below its true value and is due to go up once it goes up beyond 20. On the other hand, if the oscillator goes up to 70 or 80 then it may be overbought and the price is overvalued and may be ready for a correction that will bring it down. In this case, you can take advantage of the opportunity by short-selling currency when the oscillator falls below 80.