Momentum trading is all about the swing, and most experts agree that when looking for a swinger you need to find Mr. and Mrs. Stochastics. Kidding aside, this article will discuss the what, why, and how stochastics indicators can be used to search, identify, and get into the action on trends.
Stochastics Indicators: Swing vs. Trend
Momentum traders put less emphasis on trends and more emphasis on swings. Simply put momentum trading will not work on a market that is moving one direction for long periods of time. This effectively removes bullish and bearish markets which trend one way or the other. What swing traders look for is a sideways channel.
Stochastics Indicators: Defined
This is a Forex trading gauge that indicates momentum. This is made apparent by comparing the price of certain currency pairs or commodities starting with a specific closing day. The next step is to reference the same with a price range over a specific period of time.
Stochastics Indicators: Two Stochastic Lines
These are %K and %D indicators. The former is the main line and is usually indicated by a solid line. The latter is the moving average, indicated by broken or dotted lines. Both indicators are used to determine when to buy and when to sell. For example:
- Method 1: crossing of both lines. Bear in mind that %D is the trigger for %K. This means that when %K crosses upwards to %D Investors BUY. If %K crosses downwards to %D then Sell.
- Method 2: Remember, above 80 RSI is overbought while below 20 RSI is oversold. Now buying and/or selling must be timed at the moment nearest from the point of return from their respective thresholds. This allows Investors to use the 80 and 20 thresholds as indicators of incoming price reversal.
Stochastics Indicators: An Example
Let us assume that there is a trending market. Mr. A trades in crude oil, a commodity that is approaching oversold category. This means the RSI has fallen below 20. Mr. A looks for that specific point because when it does reach below 20 then logic and experience dictates that the same must recover or slowly move back up. The reverse is also true, for example Mr. B trades in gold, a commodity that is approaching overbought category. When the RSI reaches above 80 then it should slowly go downward and stabilize.
In Closing
Bear in mind that Forex trading is not only about stochastic indicators. There are also other indicators, charts, patterns that have to be learned in order to grow as a trader/investor. Remember, the best traders do not rely on one or two indicator before making a trade. They cross reference several charts, patterns, indicators, news of the day, expert opinion, historical data, etc. This allows them to not only determine when momentum will come but to do it with regularity and with a high degree of success. This translates to more profits with more frequency and greater accuracy. Of course one must also remember that you cannot win it all, hence a relevant stop loss order must always be in place.
